Public fund trustees, although they are supposed to be independent fiduciaries, often are under extraordinary pressure from state elected officials trying to interfere in the investment decisions.
Such an attempted intervention occurred in Illinois earlier this year. John Filan, director of the state budget office, convened extraordinary meetings with trustees of the three systems that were to receive proceeds of an unprecedented $10 billion issue of pension obligation bonds by the state.
Mr. Filan, in a number of meetings on behalf of Gov. Rod Blagojevich, advised the trustees of the turmoil in domestic and global investment markets, and of the need to be cautious in investing of the proceeds, suggesting short-term investment.
In the end, the trustees of each system decided to invest the proceeds immediately in line with their allocations to major asset classes.
The systems all report positive performance since they received their share of the proceeds July 2. In contrast, had they followed the short-term strategy, the systems would be reporting investment losses on the proceeds.
Trustees of the systems deserve praise for sticking to modern portfolio theory, rather than the political theory of investing of the governor's office.
The Illinois State Universities Retirement System, Champaign, which got $1.432 billion in pension obligation bond proceeds, earned a return of 7.55%, or $108 million, through Oct. 31, reports James M. Hacking, executive director.
SURS allocated the proceeds 70% equities and 30% fixed income. It has $11.4 billion in assets.
In that same period, Mr. Hacking noted, Treasury bills returned just 0.32%; that would have added only $4.58 million to the POB proceeds principal. The Lehman Brothers Aggregate index returned -1.19%; that would have reduced the POB principal by $17 million.
"We're delighted we didn't take Mr. Filan's suggestion of putting the money in T-bills and fixed income," Mr. Hacking said.
"Market time? We don't market time."
The Illinois State Board of Investment, Chicago, achieved a total return of 6.75% through Nov. 28 on its $1.55 billion in proceeds. "There is nothing in our policy to treat these proceeds any different than our other assets, " said William Atwood, executive director of the $8.3 billion fund.
The $28 billion Illinois State Teachers' Retirement System, Springfield, earned a return of 6% for its $4.33 billion in proceeds through Oct. 31.
For the state, the systems so far achieved a successful arbitrage on the pension obligation bonds, whose average interest rate is 5.04%. Under Mr. Filan's suggestion, the state would have lost money.
Trustees deserve praise for persevering with their long-term strategty, even in the face of what was then a poor investment market and immense political pressure. Trustees know the markets could have turned against them, bringing furies of "I told you so" from the governor's office.
The trustees' stand also was a defense of the integrity of fiduciaries, who bear responsibility for the systems. That's not easy in the politics of state government. The governor appoints a number of trustees to three systems; at ISURS, in fact, the governor appoints all of the trustees.
Mr. Filan's stance implied that bad investments got the funds into their underfunded condition with which the state now is saddled. But the state is responsible for not properly funding the systems, taking many contribution "holidays," diverting money that should have gone as pension contributions to other state programs. The pension obligation bond issue draws attention to the fact state politicians haven't been willing to fund the system on a regular actuarial basis.
With the bond issue taking care of the state's fiscal 2004 contribution, Mr. Hacking wonders where the state will get money for contributions for fiscal 2005 when it will owe an estimated $2 billion. Mr. Filan, who should be chastened and better versed in pension financing, from indications hasn't ruled out trying to influence the board on investment policy in 2004.
As Mr. Hacking notes, "pension liability growth never takes a holiday." That's a point politicians in all 50 states would do well to remember when they consider "saving" money by deferring or reducing pension contributions. If they fund the pension plans properly, they won't have to issue pension obligation bonds, or resort to pressuring the trustees.