Recent moves by the Florida State Board of Administration and the New York City Retirement Systems to adopt new compensation plans to raise the pay of investment professionals on staff recognize the constant challenge public pension funds have in competing with the private sector to attract and retain talent.
More public plan sponsors must embrace the need for competitive pay for public fund investment professionals to improve chances of meeting investing objectives and keeping retirement programs affordable in terms of contributions.
“We are in a war for talent,” Michael Williamson, executive director, State of Wisconsin Investment Board, said in a July 27 Pensions & Investments story.
There is one reason in particular trustees, and, if necessary, legislators need to act to make public pension plan professional investment staff pay levels competitive: That reason is investment returns finance most of the funding to pay pension benefits.
“Since 1984, investment earnings have accounted for 62% of all public pension revenue,” while employer contributions accounted for 26% and employee contributions, 12%, according to a February report, “State and Local Government Spending on Public Employee Retirement Systems” from the National Association of State Retirement Administrators.
Trustees have to draw attention to the issue with legislators and the public. Through competitive staffing, better oversight of asset allocation and investment management has a better chance of producing expected returns and lowering contributions from taxpayers, or at least minimizing increases in contributions.
Over the past five years, the State of Wisconsin Investment Board has paid $33 million in incentive payments to staff, while generating $1.4 billion over market returns, Mr. Williamson noted, saying SWIB's incentive pay program “is not an expense — it's an investment.”
Without the majority financing from investment returns, pension benefits at their current level would become unaffordable unless legislators step up contributions, an unlikely prospect.
Lawmakers already are facing other demands for public spending and are reluctant to raise taxes to increase pension contributions.
Pension plans must take investment risks to reach their assumed return objectives, competing globally to allocate to increasingly sophisticated asset classes and investment strategies. Reaching that objective has become more challenging in a protracted low-interest rate environment that could last for many more years. Many pension plans have diversified into alternative investments and strategies, including private equity, hedge funds, infrastructure, and even moving beyond just an allocation to real estate to add real assets in timberland, farmland, energy and other natural resources.
Stepping up investment risk requires enhancing risk management and staffing with capability to develop such policies and oversight.
The financial crisis of 2008 increased sensitivity of pension plan trustees to risk. To try to avoid another investment market collapse that resulted in losses of 25% or more of their asset values, pension plans have to diversity, often moving into new asset class and strategies, adding to the complexity of oversight.
Trustees have a responsibility to make sure pension plans have staff with the knowledge and experience to ensure their funds perform well under their investment objectives. A well-structured compensation plan, especially including incentive compensation for meeting well-designed benchmarks, as the new program at the FSBA and existing program at SWIB do, is a vital part of effective pension plan governance, just as it is in corporate governance.
In order to do so, trustees and staff have to have the capability to take advantage of opportunities in the global investment markets within the bounds of the levels they've set for taking risks.
Trustees must develop a budget to oversee assets at the level necessary to implement their investment policy. Falling short of necessary resources risks underperforming benchmarks and objectives, resulting in higher contributions to make up for lower levels of returns.
Two years ago, Robert Grady, former chairman of the New Jersey State Investment Council, cited compensation as a key factor in the departure of the then-chief investment officer as well as the co-head of investments. (The state Legislature has to approve higher pay for staff overseeing the New Jersey Pension Fund.) “Our compensation levels are low to comparable public plans,” Brendan Thomas Byrne Jr., chairman of the council, said last month. “We have had a reasonable amount of turnover at the higher levels,” he added. “That hurts us.”
Higher pay comes with no guarantee for better investment performance. But a lack of competitive pay puts plans at risk for higher contributions from underperformance and the costs of higher turnover of staff seeking more lucrative opportunities in investment management.
Without competitive pay, staff might not be up to the level of the fund's complexity to oversee asset allocation and strategy, leaving the fund vulnerable to underperforming benchmarks and raising funding costs.
The market will determine whether pay levels are competitive in recruiting and retaining talent. Public plans that design pay plans to become competitive must regularly re-evaluate compensation to keep up with the dynamics of the market for investment professionals, just as their investment program must keep up with the market dynamics to keep funding costs as low as possible.