Pension Fund Governance in the Lonestar State
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Hat tip to Robert Elder, journalist for American Statesman, who writes that a prominent Dallas financier has been jettisoned as chairman of the Texas Pension Review Board, "which oversees nearly 400 public pension systems that hold $200 billion in assets." In "Perry ousts head of pension board" (American Statesman, June 24, 2008), Elder describes Frederick Rowe as a vocal critic of alternative investment commitments by retirement plans that do not always fully consider risks.
According to its website, the Texas Pension Review Board has a variety of duties, including the oversight of "the actuarial analysis process" and making recommendations of "policies, practices, and legislation to public retirement systems and their sponsoring governments." If one clicks on "Tools," you can download the audio files of board meetings. The most recent one (dated April 10, 2008) is worth a listen as it centers on asset allocation and risk assessment with then Board Chairman Rowe criticizing a "backward-looking" approach to assessing investment performance and a reliance on investment consultants who advocate alternatives and "reduce what they call risk in patching together this crazy quilt of uncorrelated assets." (It's a large file and may take a few minutes to download.)
In its "Written Investment Policies for Public Pension Systems," the section on risk is brief and focuses on the erosive impact of inflation and the possible gap between actuarial interest assumptions and realized performance. The statement that "to increase one's understanding, one can also look at the actual rates of return and volatility for the past 25 years" caught my eye. As most financial experts know, the risk-return tradeoff, along with correlation patterns (and much more), can change dramatically over time. To rely only on historical numbers without conducting a "what if" analysis (which may be a regular activity by various Texas plans) is ill-advised. Additionally, a decomposition of a period as long as 25 years into economic "regimes" goes a long way to avoid the artificial smoothing of risk measurements. Decisions based on metrics that lower risk may not always be the best ones, putting it mildly. However, to be fair, readers are urged to describe investment objectives in terms of return (absolute and relative) as well as the risk-adjusted rate of return. It would be nice to see this document beefed up to include extensive guidance on how various risks (economic, operational, default, etc) will be measured, monitored and managed.
In a separate article ("TRS switches key outside law firm," American Statesman, July 24, 2008), Elder writes about a recent change of fiduciary counsel that has apparently upset some trustees of the Teacher Retirement System of Texas. Elder describes the decision as "unusual" because of a close split vote and imminent plans to discuss "governance policies and ethics rules in September" (suggesting that some trustees favor continuity). One pension attorney with whom I recently spoke offers that a change of fiduciary counsel is not in and of itself a red flag.
In a lengthy comment, posted to Elder's blog, Public Capital, Mr. Jim Lee, Board Chairman of TRS writes that "8 trustees voted for or expressed support" for the hiring of a new outside legal expert and that trustees unanimously voted in favor of "diversification changes in April 2007." He adds that a variety of alternative investments "will make up potentially another 30 percent of the portfolio, up from approximately 4.5 percent" as part of a "very deliberate progression." Printed page 68 of the Comprehensive Annual Financial Report (for fiscal year ending on August 31, 2007) shows a private equity target allocation of 10% with a minimum range of 5% and a maximum range of 15%. The given target for hedge funds is 4% with a minimum range of 0% and a maximum range of 5%. The target for real estate is 10% with a minimum range of 5% and a maximum range of 15%.
As stated many times herein, alternative investments are not inherently "good" or "bad." However, as more U.S. and non-U.S. plans (public and corporate) invest in alternatives, it is extremely important to understand how decisions are made with respect to risk assessment, including valuation of "hard to value" assets. In the case of TRS, with a total fund value as of August 31, 2007 of $111.1 billion, the aforementioned annual filing cites the creation of a risk committee of the board to oversee "the overall risk of the portfolio" and establish "policies and practices to measure, manage and mitigate" exposures. A second initiative is the determination of "key risk parameters", derivative instrument limits and related counterparty credit ceilings, along with addressing liquidity, operational, settlement and legal uncertainties.
Editor's Note: The Teacher Retirement System of Texas was cited as "Public Pension Fund Investor of the Year" by Alternative Investment News, an Institutional Investor publication. Click to read the June 26, 2008 press release.
