Some of the giants in the pension fund industry, including CalPERS and the New York State Common Retirement Fund, are under scrutiny. They have been regarded as among the most sophisticated investors. CalPERS, especially, is followed for its leadership on investment issues and pioneering strategies.
Yet executives at the funds have been facing questions lately over portfolio losses, allegations they took too much risk, and accusations of pay-to-play practices or other activities in conflict with managing investments solely in the interests of pension plan participants.
The market meltdown over the past year damaged these pension funds' investments, like those of other institutional investors.
But the declines in these pension funds cannot be ascribed only to market forces trumping portfolio diversification. The revelations of pay-to-play arrangements have exposed their vulnerability to possible improper relationships and costs.
The performance questions, and the pay-to-play scandals, suggest these jumbo pension funds, and perhaps many other funds, must review and tighten their governance practices.
Their enormous assets give these funds huge economies of scale, which they often properly use to allocate efficiently large sums to new investment opportunities, and to negotiate good deals with managers. But that huge scale also has made them targets of appeals to try unexpectedly risky investments, economic development efforts and political temptations.
The fact that the funds, pressured by investment losses and revelations of possible improprieties, only recently identified the problems of placement fees and disclosure, are indications of shortcomings in internal governance. This also is an indication that trustees and administrators lost sight of their objective — securing funding for the future pension benefits of state employees. It suggests the funds' scrutiny of investments was less sophisticated than generally believed.
In mid-October, CalPERS executives announced they are conducting a special review of fees paid by the fund's external managers to placement agents. The review was initiated after CalPERS executives were told by investment managers that the firms had paid more than $50 million in fees over a five-year period to ARVCO Financial Ventures LLC, a placement firm headed by Al Villalobos, a former CalPERS trustee.
Earlier this year, the New York State Common Retirement Fund began investigating at least 20 private equity and hedge funds mentioned in indictments of David Loglisci, its former CIO, and Henry Morris, a top adviser and fundraiser for Alan Hevesi, former state comptroller and sole trustee of the fund, in connection with pay-to-play allegations. Two others have pleaded guilty in connection with the case.
Since taking office in February 2007, Thomas P. DiNapoli, state comptroller, has undertaken a number of internal reforms to strengthen oversight of the fund, including banning involvement of placement agents in investments with the fund.
Better governance would help avoid such problems. Some 98% of pension fund executives in a survey referenced in “Pension Fund Excellence” by Keith P. Ambachtsheer and D. Don Ezra, cited poor process in governance as a barrier to excellence in pension fund management. Only 8% cited difficult markets.
But better governance involves more than simply appointing a board of trustees to oversee a professional investment staff.
While the criticism of the New York State fund has focused in large part on its reliance on a single trustee structure, CalPERS, with a multitrustee board, faced similar problems with placement agent issues. Boards don't necessarily avoid or resolve problems, although funds generally are better served by a board consisting of dedicated, knowledgeable trustees.
To be successful, sole trustees, as in New York, or boards, as in California and elsewhere, should keep to policy-level decisions, such as setting risk levels and asset allocation. They should delegate authority to implement policy to professional investment staff, subject to board review and approval. They should also demand more disclosure and transparency from managers and consultants, while properly accounting for the potential costs and benefits of the risk undertaken. Boards should also be watchful of consultants, who help set the allocation, to ensure they aren't favoring policies that could benefit managers with whom they have a financial relationship.
Investment returns account for a large share, some estimate 80%, of the funding of pension benefits. But many pension funds fail to produce this value. Investment performance comes from a combination of asset allocation and implementation.
For the board or sole trustee to undertake both policy setting and implementation introduces potential conflicts of interest. Trustees could skew allocations to favor personal relationships, or to satisfy political pressures.
The advantages of defined benefit plans to taxpayers, sponsors and participants over other types of retirement programs are harder to defend if plans are not well managed and become a source of favors to those overseeing them.