Show me the money

Investment losses and increasing political pressure are combining to make it more difficult for public pension plans to provide incentive compensation for their internal investment managers.

Officials in some states have attempted to block bonus payments provided under contract to pension plan investment officers who have beaten their investment benchmarks. Robert Borden, chief investment officer of the $25 billion South Carolina Retirement System Investment Commission, Columbia, saw his $176,000 bonus payment unsuccessfully challenged by State Treasurer Converse Chellis. Mr. Chellis opposed the bonus because it would come amid state funding declines and employment cuts, and because the system had lost money during the current economic crisis.

The $62.9 billion State Teachers Retirement System of Ohio , Columbus, also was besieged by objections from current and former employees about the $6 million in contractually obligated performance bonuses paid to its internal investment managers in 2008 when performance was poor. But because several managers beat their investment benchmarks, the bonuses were paid.

The political pressure surrounding investment bonuses won’t ease soon. Alan Johnson, managing director at executive compensation firm Johnson Associates Inc., New York, said such pressure will continue well into 2009 and possibly 2010 as state budgets remain under pressure and might face future cuts.

“The environment you are working in, a state that might be financially under siege and going broke, paying a bonus to someone is going to be a real problem,” Mr. Johnson said. “Bonuses are going to come under increasing scrutiny and be a bigger political football than before.”

Because state employees and their salaries are often on the public record, Mr. Johnson said payment of bonuses, ranging from 30% to 100% of yearly salary, ranging between $125,000 to $300,000, is readily available for scrutiny and fodder for public discourse. Incentive pay usually is contractual in that states say they will pay some form of incentive compensation, but the actual dollar amount is not finalized until the governing investment board decides close to the end of fiscal year.

However, Mr. Johnson said while states often retain the right to cancel incentive pay, to do so would be horrific, as investment staffs would likely leave for the private sector and its slightly higher base pay and incentive packages that could be 300% or more of base salary.

“If state plans do not pay bonuses they will not be competitive with the private sector; they are kind of forced to pay,” said Mr. Johnson.

According to the $55 billion Pennsylvania Public School Employees’ Retirement System, Harrisburg, website, the average incentive payment to internal managers for the year ended June 30, 2008 was $40,672.

External manager bonuses are normally included in their negotiated general fee structures between the state and the money management firm. The state never directly pays or compensates a money management firm manager, so the amount of incentive compensation, usually much more than their public counterparts, is not part of the public record.

“It is much harder to get state employees paid and all hell could break loose when they do get paid,” Mr. Johnson said. “Even if an internal manager beat his benchmark and saved the taxpayers money, it is a hot-button issue. The state could be officially going broke but the bonus is deserved; paying it becomes a problem.”

Vicky Hearing, spokeswoman for the $60 billion, as of Nov. 30, 2008, State of Wisconsin Investment Board, Madison, said internal manager bonuses, the sizes of which have not been decided, are expected to be discussed at the board’s Jan. 14 meeting, though it’s unclear what changes, if any, might be made. Ms. Hearing added some internal investment managers did meet their criteria for bonus payment, beating their respective investment benchmarks and meeting five-year performance criteria.

The fund’s $56.2 billion Core Trust component returned -28.3% and the $3.8 billion Variable Trust aggregate returned -40.9%, as of Nov. 30.

Robert Gentzel, spokesman for the $31.2 billion Pennsylvania State Employees Retirement System, Harrisburg, wrote in an e-mail response to questions that the plan has strict guidelines for incentive payment. For example, no incentive compensation can “even be considered” unless the plan has achieved its assumed rate of return of 8.5% for the preceding fiscal year.

"So we would never be in a position of paying incentive compensation for negative performance,” Mr. Gentzel wrote. “Only a very few of our outside managers have incentive provisions in their compensation agreements. Those that do cannot earn an incentive payment unless performance is positive. Given the across-the-board negative performance of the past year, I do not expect that any managers (internal or external) will have qualified for incentive payments in 2008.”

The fund posted losses of 11.8% in the third quarter, 14.4% in the first nine months of 2008, and 13% for the year ended Sept. 30. Mr. Gentzel said it’s expected the fund will post a negative return for the full calendar year.

The bonus brouhaha isn’t a problem for the $26.9 billion State of Connecticut Retirement Plans and Trust Funds, Hartford. According to Leanne Paladino, acting chief investment officer for the pension trusts, there are no bonuses for internal staff.

Meanwhile, the $55 billion Pennsylvania Public School Employees Retirement System’s board said in a news release in mid-December that in the fiscal year ended June 30, 2008, 21 of the system’s investment professionals earned incentive payments of about $854,000 combined. They weren’t called bonuses, but were part of an overall compensation package that’s been in place for more than 14 years, and is outlined in a policy that is reviewed and approved by the board annually. The last incentive award was approved in August 2007.

According to the release, Harrisburg-based PennPSERS is contractually obligated to pay the incentives earned for the past fiscal year. On Dec. 12, the board voted to terminate the incentive compensation plan policy for the current fiscal year, which ends June 30.