SACRAMENTO, Calif. - The California State Teachers' Retirement System board chose in-house candidate Patrick Mitchell as chief investment officer, ousting Thomas E. Flanigan.
The decision surprised Mr. Flanigan, whose eyes became moist shortly after he learned last Thursday he was being passed over after 11 years as CIO of the $68 billion fund.
Mr. Mitchell, currently director of fixed income and equities at CalSTRS, and Mr. Flanigan were only two of six candidates in the nationwide search.
Other candidates appeared to be Collette Chilton, chief investment officer of the $16 billion Massachusetts Pension Reserves Investment Trust, Boston; Peter M. Gilbert, chief investment officer of the $16.7 billion Pennsylvania Public Employes' Retirement System, Harrisburg; and Richard P. McGahan, executive director-investment management of the $20 billion Pacific Telesis Group pension fund, San Francisco. Each visited the fund's offices last week as trustees held two days of closed-door interviews for the job.
When asked whether he was a candidate, Mr. McGahan would say only "I can't discuss that." Mr. Gilbert was on vacation and couldn't be reached for comment, and Ms. Chilton was out of the office and couldn't be reached.
Emma Zink, chairwoman of the CalSTRS board and a critic of Mr. Flanigan, called Mr. Mitchell "extremely talented." He has been with the fund since 1988.
The CalSTRS job has a base salary range of $185,000 to $230,000 with a 10% bonus incentive.
Mr. Mitchell's first major task will be to make significant asset allocation changes to the system.
The day before board selected him, members sharply increased the equity allocation of the underperforming pension fund.
Trustees decided to boost equity and equity-related investments 17 percentage points from its actual current allocation. How the fund's managers will be affected by the changes will become clearer next month when an implementation plan is worked out.
Much of the re-allocation to equities from fixed income and cash
is expected to be done within a year of forming execution plans, and finished within two years. If done, the change in asset allocation will mean a movement of more than $11.5 billion - not including money from interest earnings and new contributions.
Domestic fixed income dropped
The biggest increase in asset allocation will be to international stocks and emerging markets, up to 25% from their current 18% share. The biggest loser will be U.S. fixed income, which is being eliminated. It had been 37% of assets. In its place, the board will put 26% of assets in global bonds.
Domestic equity stocks will be increased 5 percentage points to 38% from its current 33%. The CalSTRS board considered another asset allocation proposal that would have increased domestic stocks to 51% of assets.
Sources say the CalSTRS board is embarrassed over the fund's relative poor investment performance and becoming a subject of public attention. Some board members wanted to make changes in the investment office and the asset allocation with hopes of returning to what they see as the fund's traditional low profile.
Hours before the board's decision to replace him, Mr. Flanigan was hopeful of retaining his post, saying, "I am the best man for the job."
But when the decision came, "I think he (Mr. Flanigan) was stunned a bit," said James Mosman, chief executive officer. "That is difficult information to process."
Although the final vote of the board for Mr. Mitchell was unanimous, there was "intense debate," said Mr. Mosman.
He said Mr. Flanigan has "strong supporters and strong detractors" on the board.
State Controller Kathleen Connell, who voiced repeated criticism of Mr. Flanigan, was not available for immediate comment on his departure.
Why Mr. Flanigan was ousted
Mr. Mosman said he suspects board members believed Mr. Mitchell had better "management skills" than Mr. Flanigan. Mr. Flanigan was seen by some board members as an investment strategist who had difficulty communicating with some board members.
When Mr. Mitchell will take over isn't clear.
While Mr. Flanigan had been an independent contractor to the system, Mr. Mitchell will be an employee. The state approval process could take 30 days.
Mr. Mosman said he isn't sure whether Mr. Flanigan will guide the pension fund until his contract runs out at the end of June or take some vacation time. If Mr. Flanigan goes on vacation, Mr. Mitchell will serve as acting chief investment officer. Mr. Flanigan was out of the office May 9 and couldn't be reached for comment.
He was accused by some board members of market timing and resisting board policy. He also was blamed for the fund's poor performance.
CalSTRS finished 96th in the Trust Universe Comparison Service for calendar year 1996 for public funds with more than $1 billion in assets. The fund produced an average annual return of 10.6% for the three years ended Dec. 31. It underperformed its passive policy benchmark by 90 basis points per year, according to numbers from Pension Consulting Alliance, Studio City, Calif. PCA is the fund's general consultant.
Mr. Flanigan contended he was following board policy in his investment decisions. He said his investment decisions were approved by the board. Mr. Flanigan believed some board members attempted to distance themselves from their own investment policies as the domestic equity market reached new heights.
A $7 billion tactical asset allocation fund became the center of controversy because Mr. Flanigan had weighted it heavily in fixed income. But Mr. Flanigan contended the board had agreed that portfolio would be used to tilt the fund toward underpriced assets.
Asset allocation key in search
Asset allocation was a central issue in the selection of the chief investment officer. Ms. Connell, an ex-officio board member, said she was grilling candidates on their asset mix approach. Ms. Connell has been demanding CalSTRS invest more in equities.
But Allan Emkin, the board's consultant from PCA, recommended against the proposal that would have boosted domestic equities to 51% of assets. He said it was unlikely the board could reach that level in two years. Instead, the board chose the asset allocation recommended by Mr. Emkin and supported by Mr. Flanigan.
Some of the asset allocation changes will be accomplished by redirecting net cash flow, about $3 billion a year. Other changes include dropping cash to 1% from 3% and eliminating the 4% allocation to global TAA.
The allocation to alternative investments was increased to 5% from 2%, and real estate was increased to 5% from its 3%. Although the old target allocations were slightly different from the fund's current allocations, the target goals never were reached. The board members expressed determination to reach their new goals.
In an interview following the vote, Ms. Connell said she's concerned about the switch from U.S. fixed income to global bonds.
It isn't known yet how the fund's various money managers will be affected. But incumbent fixed-income managers will be out, unless they can compete as global fixed-income candidates.
