Texas to peek over shoulders of public funds

In what may be a windfall for investment consultants, a new law requires Texas public pension funds with assets greater than $30 million to hire outside firms to evaluate the efficacy of investment activities of the fund and suggest improvements in a report to the Texas Pension Review Board, Austin.

On June 10, Texas Gov. Greg Abbott signed Senate Bill 322, mandating public pension funds to provide "comprehensive analysis of the retirement system's investment process that covers all asset classes," according to the text of the law.

Texas public funds will have until June 1, 2020, to submit their first evaluation reports. Thereafter, evaluation reports must be filed every three years for plans with more than $100 million in assets and every six years for plans with assets between $30 million and $100 million. Plans with less than $30 million are exempt from the reporting requirement.

State Rep. James Murphy said he and bill co-sponsor, Sen. Joan Huffman, introduced the bill to make it easier for the Texas Pension Review Board to make apples-to-apples comparisons of the investment health of the public pension plans it oversees.

Part of their motivation was to make sure that the Pension Review Board has adequate data from each pension fund to identify plans that might be in trouble with regard to investment performance or funded status, Mr. Murphy said.

Mr. Murphy said constituents and taxpayers expressed concern to him about the status of Texas public plans between legislative sessions (Texas has a biennial schedule) after reform legislation was passed in the 2017 session to shore up the $2.1 billion Dallas Police & Fire Pension System and the $4.2 billion Houston Firefighters' Relief and Retirement Fund, the $3 billion Houston Municipal Employees Pension System and the $5.5 billion Houston Police Officers' Pension System.

"Investment performance and benefit structures can become uncoupled leading to problems," Mr. Murphy said, noting that pension funds may be able to "self-correct" deficiencies using the suggestions for improvement provided by the external reviewers negating "the need for big brother to step in."

Observers noted that Texas is home to a high number of small public pension funds and legislators likely are taking a protective stance with the legislation.

Of the 99 public pension funds in the state, 41 have assets of more than $100 million and 24 have assets between $30 million and $100 million.

"Texas has a very large number of very small pension funds, and legislators are making sure these funds are reporting information on their funding and investment policies so action can be taken if there are problems," said Timothy Lee, executive director of the Texas Retired Teachers Association, Austin.

"Requiring these plans to submit their evaluation reports to the (Texas) Pension Review Board may help identify potential problems," Mr. Lee said, noting that "the teeth of the law will be in the hands of the decision-makers, including the governor, lieutenant governor and legislators," who act, if necessary, based on the results of fund evaluations.

The review board will compile and summarize the reports of the pension funds before passing the information on to state officials.

Mr. Murphy said the Legislature is "trying to be careful about putting its finger on the scale because it's definitely a gray area" regarding local control of public pension funds and state intervention.

He said the program will be assessed between legislative sessions and legislation may be introduced to codify actions the state might take based on pension fund evaluations.

SB 322 requires Texas public funds to hire external firms experienced in evaluating institutional investment practices to review the system's investment practices, policies and performance in the previous year and to create a report with recommendations for improvement to be submitted to the Texas Pension Review Board no later than June 1 after the fund's prior fiscal year-end.

The law permits a pension system to engage a firm with which it already has a relationship, such as an investment consultant, to prepare the fund evaluation, but it forbids hiring firms that directly or indirectly manage money for the fund.

Some Texas public pension funds, including the Austin-based $145.4 billion Teacher Retirement System of Texas and the $2.7 billion City of Austin Employees' Retirement System, said they might turn to their existing investment consultants to prepare fund evaluation reports.

Among the specific areas for review are the system's strategic investment plan; detailed analysis of the plan's asset allocation, including the process for determining target allocations; expected risk and return; the method for selection and valuation of alternative and illiquid investment strategies; and the appropriateness of investment fees and commissions.

The Texas Pension Review Board "understands the timeline Texas public retirement systems face in meeting the new requirements in SB 322 and will make every effort to finalize guidance for the systems as early as possible," particularly regarding investment performance evaluations and enhanced investment fee disclosures, said Ashley Rendon, a review board management analyst, in an email.

Senate Bill 322 also requires that Texas public pension funds list investment managers and provide direct and indirect investment fees by asset class in their annual financial reports. The law also mandates posting annual investment reports on a pension system's website or another publicly available site.

Sources said Texas is the only state to mandate detailed reporting on the public pension fund investment aside from South Carolina, which enacted a similar law in 2017.

"The general trend is to increase disclosure voluntarily to avoid having it legislated," said Randall W. Miller, principal and chief operating officer at governance consultant Funston Advisory Services LLC, Bloomfield Hills, Mich.

Mr. Miller said funds such as the $210.2 billion New York State Common Retirement Fund, Albany, for example, releases monthly reports detailing investment activity, new manager hires and information about placement agents, but the report lacks disclosure about investment fees.

Other sources agreed that Texas' new law expands the level of disclosure required of public pension systems.

"What makes this law unique is the breadth of the regulation. While many elements were already covered in GASB 67/68, the level of detail required for commissions and fees sets a new level of disclosure standards," said Leon F. "Rocky" Joyner, Atlanta-based vice president and actuary, public-sector retirement practice leader, Segal Consulting.

Most of the state's large public retirement systems already capture the investment information mandated by the new law.

Meeting the reporting requirement "won't be a big lift" for Texas Teachers, said Brian Guthrie, executive director, given that most of the required information already is being collected by the pension fund and the system's consultant, Aon Hewitt Investment Consulting Inc., as part of regular reporting.

Mr. Guthrie said fund officials are waiting to hear from the Texas Pension Review Board to get specifics regarding what will be required for the evaluation report.

Keith Yawn, director of the office of strategic initiatives at the $29.1 billion Employees' Retirement System of Texas, also said "there won't be a lot of change" to what the fund already reports in the state evaluation report.

The City of Austin Employees' Retirement System "supports the bill's transparency requirements and the focus on fiduciary standards," but because SB 322 requires plans to pay an evaluation firm, the cost burden on smaller plans may be high, said Christopher Hanson, executive director.

COAERS "already collects the vast majority of what the legislation requires," Mr. Hanson said, but having the fund's investment consultant, RVK Inc., gather required information and evaluate the system's operations will cost about $40,000.

The cost would be even higher if COAERS hired another consultant, which would need more time and labor to study the system.

In other legislative action related to pension issues in the 86th Texas Legislative session, Mr. Abbott signed Senate Bill 2224 on June 4, which requires boards of trustees of public pension funds of all sizes to adopt a written plan for achieving a funding ratio of 100% or higher no later than Jan. 1, 2020.

On June 10, the governor signed SB 12, which will gradually increase contributions to the Texas Teacher Retirement System from the state, school districts and employees to bring the plan to fully funded status in 29 years down from 87 years (Pensions & Investments, May 29).