BALTIMORE - Trustees at the State Retirement and Pension System of Maryland were stunned last month when they learned their pension fund had placed last in the Trust Universe Comparison Service's ranking of 38 funds with assets of more than $1 billion. The system lost $3.6 billion in the fiscal year ended June 30, sliding 9.6% for the period.
The system, which had $29.4 billion in assets as of Nov. 13, does not use the TUCS rankings as a benchmark because not enough information is available about the other 37 funds against which it was being compared, said Peter Vaughn, executive director at the Maryland fund. Instead, Maryland measures its performance against a weighted average of its managers' benchmarks and its 8% assumption rate.
As a result of the multibillion loss and its poor performance in fiscal 2001, the system has come under fire from the state's Joint Pension Committee, a legislative panel that oversees the system. In its annual report on the system's performance, the committee publicly announced the poor ranking and called for SRPS to start using the TUCS ranking system. It also criticized the system for having too high an allocation to equities.
As of June 30, the equity allocation had swelled to 72% of assets, including 5% in real estate. But by Oct. 31, as the stock market rallied, the allocation had fallen to 64% of assets, including 5% in real estate, which was closer to what other funds have, Mr. Vaughn said. According to Pensions & Investments' 2001 sponsor directory, for the year ended Sept. 30, 2000, the average public pension fund had 46.9% of total assets allocated to domestic equities, 14.3% to international equities and 3.4% to real estate, for a total of 64.6%.
He added that in the last year the poor performance of international equities hurt overall performance the most. The international stock component had surged to 23.6% of total assets by the end of June, and has since been reduced to 20% of assets. "But we lost less than EAFE, our benchmark, which was down 23%, while we were down 21% in the period," Mr. Vaughn noted.
Not enough information
He argued that it doesn't make sense to use the TUCS rankings because too little is known about the other pension funds in the TUCS $1 billion-plus universe. "We used to get their reports at our planning conferences and decided in 1996 that it was not relevant because it was comparing apples and oranges, and we'd rather compare apples and apples. Some funds in there were around $1 billion in assets. Others were near $150 billion. We didn't know who they were, their asset allocation, what their risk parameters were, or on what basis they were measuring. The board directed staff not to provide it any more, so we didn't."
Many large public pension funds use the TUCS ranking service as a benchmark, and fund officials see the reports even if they don't make specific use of the information, because its clients are the banks that serve as the custodians of the pension funds. TUCS, a subsidiary of Wilshire Associates, Santa Monica, Calif., is highly secretive about its ranking strategy and which pension funds it ranks. Kim Shepherd, spokeswoman for TUCS, said, "Our clients won't allow us to say anything about it to anyone."
Internal benchmarks
Many public funds, like Maryland, prefer to use internal benchmarks. Lisa Mazzocco, principal officer for equities at the $26 billion Los Angeles County Employees Retirement Association, Pasadena, Calif., said LACERA measures its total fund performance against customized benchmarks. "Different funds have different allocations, which makes comparisons difficult. In addition, some custodians don't get the information on all of the asset classes such as private equity or real estate, so you can't really compare them."
Because of the joint pension committee's recommendation, the TUCS issue will be revisited and discussed at the system's next investment committee meeting on Dec. 14. Said Mr. Vaughn: "If the joint pension committee insists that we use it, we will."
The joint pension committee has other complaints. It is asking the system to consider hiring its first outside consultant and to redo its asset allocation policy, which was set in March 2000. Staff also is studying these issues and will report on them at the December meeting.
Mr. Vaughn observed SRPS had never felt the need to use an outside consultant. "We have three voting members on our investment committee who have financial expertise, who serve as consultants. We call them the `three wise men,' and they help us with our investment strategy. When we need expertise on a certain issue, we get it issue by issue. We have always felt that consultants don't add much value, especially considering that we have had only two bad years out of 17, always without an investment consultant. The board hasn't thought there was any value to them before this, either."
Maryland has a long-term outlook, Mr. Vaughn emphasized, pointing out that as a result of increasing equity exposure from 35% in 1991 to 67% in 2001, the system's underfunded status dropped considerably. "In 1991, it was underfunded by $6.5 billion, compared to 2001, when it was underfunded by $750 million." The increased equity allocation also accounted for a surge in size, growing from $12.6 billion in 1991 to $29.5 billion in 2001.
"Many others (other funds) were in the same boat last year. Others might have been more conservative, but history has showed that by being in stocks over time, you're rewarded if you're in it for the long term. The board's risk appetite can change. We have to decide if we're comfortable taking the risk. We do an analysis (of the asset allocation policy) every spring. But in the end, I don't think the board wants to make a knee-jerk reaction to short-term events, since we're long-term investors."
Arthur Caple, chairman of the investment committee and executive director of the state's supplemental retirement plan, said the 64% allocation to equities is in line with equity allocations at other public funds in the system's peer group, those with assets from $20 billion to $50 billion. "Staff is doing a comparative analysis of those pension funds, which is to be presented at the December meeting."
But making frequent changes to the asset allocation is not a prudent move, Mr. Caple asserted.
"The system reviews its managers every year, and none of them are exactly setting the world on fire. But we're in it for the long term, and have to base our review of them on three to five years of performance. If we make short-term bets, we'll be firing people, which costs money. It will mean that we're selling our assets low and buying high. My opinion is that we should stick with what we have," he said.
Current allocation
The current asset allocation policy was essentially the work of Richard Dixon, state treasurer and chairman of the board, said Frank Cappiello, president of McCullough, Andrews, Cappiello, Baltimore, an investment firm that advises wealthy clients and small institutions. Mr. Cappiello served on the investment committee for 17 years until 1996, and he still follows the fund. Mr. Cappiello thinks Mr. Dixon should have cut back on equities in the last year as the stock market started to slide. "Moving to an allocation of over 72% was extremely aggressive, at a time when the market was selling at an all-time high. During my time at the system, when we did increase stocks, we never approached anything like 70%."
Mr. Dixon defended the high stock allocation. "It's been very successful for us," he said. He has no plans to lower the exposure.
One trustee who opposed the high allocation was Carl Lancaster, a retired teacher. "Equities had been at a range of 50% to 70%, and in March 2000, the board approved letting it go up to 80%. I thought that with the current high valuations, it didn't merit increasing it," he recalled. "But I was the only person to vote against it.
"We haven't changed the asset allocation since that time, although we review it on an ongoing basis. I have concerns about the allocation, but I also agree with the investment committee's decision not to sell now, because we'd be losing money," Mr. Lancaster said.
