Monday, July 22, 2013

Hefty Payouts For PSP's Executives?

The Ottawa Citizen published an article by Jason Fekete, Federal public service pension board executives’ earnings rise by half to $16 million, report finds:
The five top-paid executives at the Public Sector Pension Investment Board, a federal Crown corporation, were awarded more than $16 million in total compensation for the 2013 fiscal year — a roughly 50 per cent increase over the previous year — as the organization posted record investment returns, reveals a new report.

The eye-popping payouts to executives at the federal organization — which invests funds for the federal public service, Canadian Forces and RCMP pension plans — come as the Conservative government lays off thousands of federal workers, reforms the public service pension plan and digs in its heels on contract negotiations with some federal unions.

Investment board officials note, however, the organization does not receive a budgeted annual appropriation from government like some Crown corporations, and is a self-sufficient entity that operates from the returns it earns from pension plan investments. The income earned by the investment board is allocated to federal pension funds to pay off the obligations owed to plan members.

The board’s 2013 annual report shows the total compensation awarded to the five highest-paid executives totalled about $16.3 million — almost 50 per cent more than the $10.9 million awarded in 2012.

“These awards fairly reflect our current pay-for-performance approach,” says the report, tabled this week in the House of Commons.

The pension investment board, following a compensation review, has subsequently approved changes that will, going forward, reduce the maximum potential payouts to senior executives.

Gordon J. Fyfe, board CEO, was paid $5.3 million in the fiscal year ending March 31, 2013, including $500,000 in base salary, more than $1.7 million from the short-term incentive plan, and $2.4 million from the long-term incentive plan.

He was also awarded almost $520,000 from “restricted fund units,” more than $35,000 in benefits and other compensation, and $72,200 from pension and supplemental employee retirement plans. In the previous 2012 fiscal year, he received $3.4 million in total compensation.

The incentive plans for executives, which are based on rolling four-year periods, paid “maximum or close to maximum payouts for many senior executives for fiscal year 2013,” the report says.

The hefty payouts were tied to the investment board’s strong performance over the past four years, which saw $3.7 billion of value added to the pension funds over and above benchmark returns, the report says. Over the four years since the financial crisis of 2008-2009, the investment board has achieved an annualized return of 12.2 per cent.

“It’s a pay-for-performance model. If you have good (performance), then the incentive plans have payouts, and if you don’t have the performance then they don’t pay out,” said board spokesman Mark Boutet.

“This year, it was our best performance against our benchmark in the whole history of the organization.”

Indeed, senior vice-presidents Daniel Garant (public markets investments) and Neil Cunningham (real estate investments) both earned more than $3 million in total compensation, including more than $300,000 each in base salary, and more than $1 million each in both short-term and long-term incentives.

Fellow senior vice-presidents Derek Murphy (private equity investments) and Bruno Guilmette (infrastructure investments) were paid $2.7 million and $2.1 million respectively.

Incentive compensation is the largest component of the total remuneration paid to the board’s executives, with short-term and long-term financial incentives based on rolling four-year periods. The board says the incentive compensation structure rewards outstanding performance while discouraging undue risk taking.

The Conservative government has adopted changes to the public service pension plan that, over time, forces federal workers to increase their contributions to 50 per cent and equal those of the employer. Also, the government has increased the normal age of retirement for new federal workers to 65 from 60.

The pension investment board reports to Treasury Board President Tony Clement, but it’s an arm’s-length organization that establishes its own compensation levels, say federal officials. The government directed questions back to the Crown corporation.

The organization’s board of directors — which is appointed by the government on the minister’s recommendation — approved the compensation payouts, based on a policy that “aims to maintain total compensation at a fair and competitive level.”

The federal auditor general and outside auditor Deloitte conducted a special examination in 2011 of the pension investment board’s compensation framework and found its incentive programs are comparable to industry practices.

The Public Sector Pension Investment Board is one of Canada’s largest pension investment managers, with approximately $76.1 billion of assets as of March 31, 2013.
In my last comment, I covered PSP's fiscal year 2013 results, praising them for the strong performance they delivered over the last four years. I explicitly left out a discussion compensation at PSP because I saw no major issues and think the strong four-year performance justified the compensation they earned.

The article above serves no purpose but to anger federal government employees who have experienced  layoffs and major reforms in their public sector pension plan.

A few points for you to consider when reading articles on compensation at large Canadian public pension funds:
  • First, while payouts for top executives at PSP were hefty, they weren't the only big payouts in Canada. Top executives at the Ontario Teachers' Pension Plan earned more than their counterparts at PSP for the simple reason that they performed better over the last four years.
  • The annual reports of Canadian pension funds discuss compensation in great detail. There are no surprises. It is based primarily on long-term incentives and reflects four-year performance. When you see a jump in compensation, it means the funds are performing well. This is good news, not bad news, and plan members should be pleased, not disappointed.
  • PSP Investments and the Canada Pension Plan Investment Board are Crown corporations that operate at arms-length from the federal government and do not receive a budgeted annual appropriation from government like some Crown corporations. They are self-sufficient entities that operate from the returns they earn from pension plan investments. 
  • In order to attract and retain talented individuals to manage money internally, Canadian pension funds have to compete with the private sector. Compensation in the investment management industry has come down somewhat since the crisis but it's still high. Note the heads of Canadian banks are among the best paid CEOs in North America, and according to Bloomberg, three of them rank among the most overpaid.
  • Unlike banks, mutual funds and hedge funds, Canadian pension funds emphasize long-term performance. Compensation is better aligned with the interests of plan members. There is a reason why Canada's top ten are receiving accolades. It's because they are delivering exceptional results at a significantly lower cost. To do this, they got the governance right, paying their investment managers competitively for delivering long-term results. By contrast, U.S. pension funds still face huge hurdles when it comes to compensation.
  • Lastly, compensation at Canadian pension funds varies. Ontario Teachers', PSP and CPPIB pay more than their counterparts, some of whom are plagued by politics and the relentless scrutiny of the media. Can you imagine the uproar if the Caisse paid out similar compensation to their top executives? It's a shame because this organization is losing excellent people who are departing the province for better opportunities elsewhere. 
Having said this, will add some critical points that need to be taken into consideration when looking at compensation at large Canadian pension funds:
  • Policy portfolios matter: When I started this blog in 2008, I focused on alternative investments and bogus benchmarks. I've tried to demystify pension fund benchmarks because it's important to understand the risks pension funds take to beat their benchmarks. Admittedly, I've been overly critical and cynical in the past about alternative assets, stating the shift into private equity, real estate and infrastructure was to "game benchmarks" to handily beat them and obtain huge compensation. The truth is benchmarking alternative investments isn't easy and the shift into alternatives is a direct consequence of the volatility and low risk-adjusted returns in public markets.
  • Not all policy portfolios are created equal: While I understand that policy portfolios vary from fund to fund, we need more transparency to understand benchmarks used to determine compensation at Canadian funds. For example, PSP and CPPIB have the exact same fiscal year (ends March 31st). CPPIB returned 10.1% in FY 2013, edging its policy portfolio by 0.2% while PSP returned 10.7% in FY 2013, trouncing its policy portfolio by 210 basis points (10.7% vs 8.6%). Why did CPPIB's policy portfolio deliver 9.9% during fiscal year 2013 while PSP's gained 8.6%? Over the last four years, CPPIB's policy portfolio gained 11.1% vs 10.5% for PSP's policy portfolio. I looked into this and found one reason is that CPPIB uses the Investment Property Databank (IPD) as their private real estate benchmark while PSP uses cost of capital which is significantly lower. The tougher benchmark is one reason why contribution of real estate investments to portfolio value-added at CPPIB over the last four years is significantly lower than the contribution of real estate investments to portfolio value-added at PSP during that same period. So, while I praise the excellent performance of PSP's real estate investments over the last four years, I recognize that PSP's policy portfolio isn't as tough to beat as CPPIB's policy portfolio. The question then becomes even though PSP outperformed CPPIB in FY 2013 and over the last four years, is it fair to pay CPPIB's executives less compensation than those at PSP if they have a tougher policy portfolio to beat? Yes, based on four-year results (12.2% vs 10.8%), PSP's executives should be paid more (note: even if PSP had CPPIB's policy portfolio, they would have still added significant value-added over last four years). The point, however, is that it's critical to understand key differences in benchmarks and that value-added over the policy portfolio varies because some benchmarks in private markets are much tougher to beat at some funds.
  • Leverage matters: Another issue arises when looking at the leverage funds take to deliver their results. Some Canadian pension funds are not able to take on the leverage that others are taking. One risk manager expressed concerns over the commercial paper some Canadian pension funds are  issuing to invest in private markets. He wrote me this can come back to haunt mature funds with big deficits. Another senior officer at a large Canadian pension fund told me he cannot take the leverage that Ontario Teachers' and others take because provincial legislation prohibits it. Again, I ask, is it fair to pay top executives more if they are able to take on leverage that other funds can't? Some think so because they think the intelligent use of leverage is part of smart investment management but others worry that leverage exposes these funds to significant downside risk.
  • The 2008 bonus bonanza: I was extremely critical of some large Canadian pension funds after they doled out big bonuses after sustaining big losses during the crisis. While the reality is that compensation is based on four-year returns and terms of the contract have to be honored, the optics of doling out bonuses when funds lose 20%+ during a terrible year just don't look good and exposes these funds to harsh media scrutiny. 
In this comment, I've covered some of the issues surrounding compensation at large Canadian public pension funds. While I'm convinced that a big reason behind the success of Canada's top ten is that they got the compensation right, there remains a  lot more work to explain why compensation varies between funds.

In particular, some Canadian public pension funds need to do a better job explaining the benchmarks used in determining their policy portfolio and why these benchmarks appropriately reflect the risks they're taking. They also need to be a lot more transparent about the leverage they're using in all investment activities and how this figures into their compensation.

Below, the CBC reports that the highest-paid banking executives in North America are Canadian. There is controversy surrounding compensation at Canada's big banks. All I know is that Canadian public pension fund executives are paid based on long-term performance and some of them would be better off in the private sector. Keep that in mind the next time you read an article questioning their compensation.