Tuesday, August 12, 2008

What Can Canadian Pension Funds Learn From Florida's SBA?

I read an article, Florida ranks high among public pension funds, that caught my attention today. The article discusses how the $126.9 billion Florida Retirement System Pension Plan Trust Fund, intended to provide retirement benefits to more than 900,000 state and local government employees and retirees, continues to be one of the strongest in the United States. Despite a loss on investments in 2007, the fund remained more than fully funded at the end of the state’s fiscal year on June 30.

According to the article:

The Florida pension fund ended the fiscal year with a positive funded ratio estimated at 105 percent, compared to the national average funded ratio of about 81 percent, the release said.

The ratio is a measure used to gauge the health of pension funds. A funded ratio measures whether a pension plan has enough assets on hand to meet promises made to retirees.

The positive ratio helps relieve pressure on participating governments throughout the state that are facing strained budgets, Milligan said.

During the fiscal year, the pension fund lost 4.4 percent on investments. Over the same time, the domestic stock market was down 12.7 percent and the foreign equity stock market was down 7.6 percent, the release said.

The Florida fund ranked in the top half of the best-performing corporate and public pension plans, the release said, citing a report from Wilshire Trust Universe Comparison Service. The Florida fund has earned an average 9.9 percent over the past five years, the release said.

The Florida Retirement System Pension Plan Trust Fund, the fourth largest public retirement plan in the United States, is one of 33 investment funds managed by the State Board of Administration, an investment management organization for the state. The SBA manages funds with total assets valued at $154 billion.

I visited SBA's website and carefully read the statement of investment policy that governs the Florida fund. Now, as is often the case with these state investment boards, the Governor and Attorney General of the state sit on the Board which delegates to the Executive Director the administrative and investment authority, within the statutory limitations and rules, to manage the investment of Florida retirement System's (FRS) assets.

I am not a big fan of mixing politics with pension investments because there is always the potential for misguided political interference. However, in this case, the mix has worked and the investment policy clearly states that:

The mission of the State Board of Administration is to provide superior investment and trust services while adhering to the highest ethical, fiduciary and professional standards.

The thing that struck me reading this investment policy is how clear it is in terms of the role and responsibilities of the Board, the Executive Director, the investment objectives, the target portfolio and asset allocation ranges (including expected risk and returns) and the performance measurement.

You will also note that there is nothing fancy here. In fact, the target allocation to fixed income assets is 28%, which makes sense given that it's a public pension fund. Their target allocations to real estate (7%) and private equity (4%) are sensible and not overwhelming. They are not trying to mimic the Harvard or Yale endowment funds (an impossible goal for any public pension fund); they are simply trying to deliver the required actuarial return with minimum risk.

I copied Table 4 from this investment policy above to demonstrate what I consider to be clear benchmarks for various asset classes (click to enlarge image). As you can see, the benchmarks used to evaluate Real Estate and Private Equity represent the risk and the beta of those asset classes.

Importantly, the benchmarks governing these private markets do not offer the investment staff any easy way to add value to the composite benchmark.

In terms of reporting, the Board directs the Executive Director to coordinate the preparation of quarterly reports of the investment performance of the FRS by the Board's independent performance evaluation consultant. The investment policy clearly states that the following formal periodic reports to the Board shall be the responsibility of the Executive Director:
  • An annual report on the SBA and its investment portfolios, including that of the FRS.
  • A monthly report on performance and investment actions taken.
  • Special investment reports pursuant to Section 215.47(6), Florida Statutes.
The key here is transparency. There is nothing concealed or obfuscated and the benchmarks used to evaluate investment performance are clearly stated and the results are clearly reported on a timely basis and verified by independent external consultants. (Some U.S. pension funds, like the Alaska Permanent Fund Corporation even publicly disclose Board minutes, resolutions and consultants on their website.)

Moreover, SBA's 2006-2007 investment report provides details on the investment managers for each asset class and how the asset mix changed over time.

Finally, I can assure you that no public pension fund manager in the United States is getting compensated as highly as some public pension fund managers get compensated here in Canada. There is however one major Canadian public pension fund that also keeps things simple: BC Investment Management Corporation (bcIMC). The latter fund does not get the glowing accolades or press coverage of some of its better known peers but it manages to deliver consistent results without delving into fancy exotic strategies or taking undue risks.

Canadian pension funds can significantly improve their governance by looking at some of the U.S. pension funds. In particular, they should pay attention to the investment policies, how they report their results and what other information is publicly available (like publicly available Board minutes and resolutions which should be required by law for every public pension fund).

When it comes to improving pension governance, remember the three Ts: transparency, transparency, transparency!

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