Virginia's Bonus Bonanza?

Steve Contorno of the Washington Examiner reports, Va. pension managers get bonuses despite declining performance:
The managers of Virginia's pension fund got bonuses in 2010 and 2011 even though they failed to meet the benchmarks that would justify such payouts, a new report shows.

Investors for the Virginia Retirement System used to get bonuses based on the pension fund's performance. No one received a bonus in fiscal year 2009, and afterward the fund's trustees changed the system so that they -- and not a performance benchmark -- would decide who got a bonus.

A year after the system was changed, VRS employees shared $2 million in bonus payouts even though the pension fund did worse than in 2009, the Joint Legislative Audit and Review Commission reported Monday. After meeting benchmarks in 2012, staff split about $3.7 million, roughly the same amount employees received in 2011, when goals were not hit.

The state auditors faulted the new system, which they said led to "disproportionate reliance on qualitatively, subjective measures of performance" and inappropriate bonuses. VRS said it was examining its bonus policies.

"This is something that the VRS board looks at and will be continuing to look at in the upcoming year," said VRS spokeswoman Jeanne Chenault.

The auditors will re-examine VRS' policies next year to see if the system has improved.

Sen. John Watkins, R-Midlothian, who sits on the audit committee, said the pension fund has to pay performance-based bonuses because it competes with the private sector for investment managers.

"If we unloaded all of this work into the private sector, you're going to pay a premium for the work done," Watkins said. "[But] we've got to keep a good eye on this thing and make sure the performance match ups with the incentives they're being paid."

Virginia Gov. Bob McDonnell and lawmakers took steps this year to shore up VRS by requiring state workers to pay more toward their retirements and fully funding pension obligations in 2013 and 2014. But the audit found that the pension fund's shortfall is growing. VRS was 70 percent funded in 2011, but that dropped to 65 percent this year.

"The governor recognizes the challenges presented from unfunded liabilities in the pension system," said McDonnell spokesman Paul Logan.

Auditors told lawmakers in Richmond on Monday that the pension fund should be solvent late within the next decade.

"I'm probably not going to be here for another 14 years, so if someone goes in and upsets the applecart, all bets are off," Watkins said. "If we stay the course, we'll get back to where we need to be."
On its website, VRS reports that it achieved a 1.4 percent net return on its investment portfolio for fiscal year 2012, ending the year with $53.3 billion in assets:
“We are pleased with the results we were able to achieve in a market fraught with volatility and depressed returns. In fact, the staff's skillful performance allowed them to beat the benchmark for the fund as a whole last year,” said VRS Chief Investment Officer Ronald D. Schmitz.

During fiscal year 2012, the fund's real assets program returned 11.9 percent. The private equity program returned 10.9 percent, the fixed income returned 7.9 percent and the credit strategies program returned 1.4 percent. The public equity program returned -4.6 percent, reflecting the market shifts during the year.

The portfolio included $21.8 billion in public equity, $12.5 billion in fixed income, $7.2 billion in credit strategies, $4.8 billion in private equity and $4.3 billion in real assets, as of June 30, 2012.

“Although the market did not produce the returns we had hoped for, our staff made the best of a difficult global market, taking advantage of every opportunity to protect the portfolio and add value. Realistically, the world has not recovered from the 2008 financial meltdown, and it is still a difficult time to be an investor. As the market has become more volatile, the Board of Trustees has redoubled its focus on the appropriate asset allocation and risk profile for the trust fund,” said VRS Board Chairman Diana F. Cantor.

VRS serves approximately 600,000 members, retirees and beneficiaries. The active employees include about 147,000 teachers, 104,000 local government employees and about 91,000 state employees. In addition, VRS provides benefits to over 162,000 retirees and beneficiaries. The retirement system ranks as the nation's 22nd largest public or private pension fund.
There are two issues here. First, let's look at bonuses. A list of VRS's annual reports is available on their website here. I looked into the comprehensive 2011 annual financial report but couldn't find details on compensation doled out to senior managers.

I did however find details on investment managers, investment fees and brokerage commissions. In fact, on page 102, there is a list of brokers and how much each got in brokerage commissions (Canadian pension funds take note, you're all sloppy when it comes to divulging details on which brokers received what amount in brokerage commissions).

To get information on compensation and bonuses, I visited Virginia's Joint Legislative Audit and Review Commission (JLARC). There I found a list of VRS oversight reports and actuarial audits but the latest report on VRS is not available yet in their reports section. You will find a VRS semi-annual investment report published in July 2012, but there are no details on compensation and bonuses.

Nonetheless, whenever I read state auditors using words like "disproportionate reliance on qualitatively, subjective measures of performance," I know something really stinks in the way they're compensating senior pension fund managers.

I've long criticized compensation at US public pension funds. Most pay peanuts and get monkey results. The entire governance structure at most US public pension funds is all wrong, with undue political influence which limits their ability to attract and retain qualified staff.

In Canada, they got the governance right. They set up independent investment boards that operate at arms-length from the government to supervise large public pension funds and plans. These boards oversee all administrative and investment matters. They also set up compensation policies that are in the best interests of stakeholders and review them annually.

And even in Canada, we don't always get bonuses right. I blasted CPPIB for doling out huge bonuses after losing 19% in FY 2009. CPPIB's senior managers were all smiles but the press and politicians had a field day attacking them. The same thing happened with PSPIB, whose CFO got roasted in Ottawa, and at Ontario Teachers' which crashed and burned in 2008 (leverage and illiquid hedge fund investments burned them badly).

But no matter how critical I've been on Canadian pension fund managers receiving outrageous bonuses after the 2008 crisis, their bonuses are based on four-year rolling returns and more importantly, are determined by value added over their policy portfolio. We can argue about which funds use the best benchmarks for each asset class but by and large, Canadian public pension funds have gotten the governance right.

In the US, some large pension funds have started a crusade against fees but few have the compensation system to attract and retain qualified investment managers in public and private markets. None of them have internalized public and private assets to the extent large Canadian public pension funds have.

Finally, as far as auditors telling lawmakers in Richmond on Monday that Virginia's pension fund should be solvent late within the next decade, think they're smoking some hopium. While the situation isn't as grave as public pension fund critics make it out to be, the returns will be substantially lower over the next decade and Virginia and other states have to revise their rosy investment assumptions downward.

Below, VSCPA member James Shepherd, CPA, sounds off about the VRS changes approved by Gov. Bob McDonnell  back in June. As you all know, I'm dead set against defined-contribution (DC) plans and think these so-called "hybrid" plans are just as bad and will end up hurting members during their retirement years.

And Illinois Governor Pat Quinn discusses the state's battle to control public employee pension costs and the possibility the state’s credit rating will be downgraded again. Quinn, speaking to reporters at Bloomberg's Chicago bureau, also talked about his approval ratings.