Pushing back on PE and HF fees. Interview: Paul Matson, AZ Retir. system

11 / 30 / 2011
by Charles Skorina | Comments are closed

Pushing back on fees; Talking to the top guns

Comings and goings: Alaska, New York, Illinois, California, and Connecticutt

What we’re reading: Pushing back on private equity and hedge fund fees

The view from Phoenix: A conversation with Paul Matson, AZ Retirement System

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Comings and goings:

Jay Willoughby: Another hedgie heads to Juneau

For the second time in four years Alaska Permanent Fund has picked a hedge fund manager as its CIO. The $40 billion sovereign wealth fund has hired Jay Willoughby, previously a co-managing partner at Ironbound Capital Management in Princeton, New Jersey.

Ironbound, founded by former Merrill Lynch star Steve Silverman in 2002, quietly folded up and went away back in April after returning investor’s money. No one was saying exactly why they closed but, in any case, Mr. Willoughby was then at liberty, and he beat out 52 other candidates to land the job in Juneau.

Previous CIO Jeff Scott left in August to join at Wurts Associates in Seattle and executive Director Mike Burns has been filling in as interim CIO while the board sought a permanent successor.

Scott ran his own small hedge fund, Tahoma Capital, back in 2005-2007 and; before that, ran $60 billion in a hedge-fund-like absolute-return portfolio for Microsoft Corporation.

Some patriotic Alaskans had given him grief for keeping a house down in Seattle where his family lived. The Juneau Empire has reported that Mr. Willoughby and his wife will, indeed, be taking up residence in beautiful Juneau (population 31,000).

Mr. Willoughby’s base salary according to APF will be $325 thousand. This is slightly more than Mr. Scott’s $319,583 take-home in 2010.

Mr. Willoughby has an MBA from Columbia University and, like his former boss Steve Silverman, he’s a veteran of Merrill Lynch in New York, where he ran money for high-net-worth individuals.

I spoke to Jeff Scott the other day about the appointment. He said: “Mike Burns and the APF board know what they’re doing, and they wanted a money-manager rather than someone with a conventional non-profit CIO resume. APF is a public agency, but they’re not a pension.

As you know, Charles, we were moving toward a more risk-based approach to asset allocation in Alaska, and I think it’s something that will suit a hedge-fund veteran like Jay. I’m proud of the innovations we made at APF, and obviously Mike thinks Jay is the right guy to carry the ball.”

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Lee Ann Palladino: Always the bridesmaid; finally the Bride

Lee Ann Palladino has twice served as interim chief investment officer at Connecticut’s $22.4 billion RPTF pension. Now she’s been picked as their new permanent CIO.

When Susan B. Sweeney left the CIO job back in 2007, the board appointed Ms. Palladino, then manager of the pensions’ short-term funds, to be interim CIO.

State treasurer Denise L. Nappier, the state’s Investment Advisory Council and executive searchers Korn/Ferry undertook an “exhaustive” national search to unearth Tim Corbett, a candidate with “impeccable” credentials. He also happened to have “deep roots” in bucolic Farmington, CT, just ten miles from the treasurer’s office in gritty downtown Hartford.

Ms. Nappier even went the extra mile, pushing through a big pay-hike which raised the CIO’s maximum salary from $250 thousand to $350 thousand (with no bonus opportunity). Mr. Corbett’s actual salary in 2010 was $324,207 according to public records.

Ms. Palladino was appointed to a new Deputy CIO position as Mr. Corbett came aboard in July, 2009.

Unfortunately, Mr. Corbett took his impeccable credentials up to MassMutual in Springfield less than two years later, becoming their new CIO at, we suspect, much more than $350 thousand.

We note, by the by, that RPTF paid Korn/Ferry $194 thousand in 2008/2009, presumably for the Corbett hire (per their 2010 annual report). That’s about 60 percent of his first-year salary, which is pretty rich by industry standards.

So, again, Ms. Palladino has filled the breach as interim CIO for the past six months. But this time she was rewarded with the top job and, we hope, Mr. Corbett’s compensation package. Sometimes patience is rewarded.

Ms. Palladino has a BS in finance from Skidmore College in beautiful Saratoga Springs, New York; thirty years experience in investment management; and both CFA and CAIA credentials.

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Dhvani Shah and Michael Walsh: Two new CIOs for Chicagoland

Dhvani Shah:

Dhvani Shah, private equity chief at New York State Teachers pension, has signed on as CIO of the $23 billion Illinois MRF pension in suburban Chicago.

Ms. Shah is a fellow University of Chicago MBA, albeit of a slightly more recent vintage. And she has other Chicago roots, with a BA from Loyola and a five-year stint at the Northwestern University endowment before moving to New York.

Back in Albany she was responsible for moving NYS Teachers from a traditional U.S.-based fund of funds private equity program to an in-house global PE program running a $13 billion allocation. She previously spent eight years working on private equity deals for Bank of America. It’s an impressive resume for a relatively young woman.

There has been no indication that MRFI plans to expand its private equity allocation, but they now have the talent to do so if they see fit.

Ms. Shah succeeds Walter P. Koziol, who is retiring after twenty years on the job. We weren’t able to ascertain his salary, but, whatever it was, he deserved every penny. Mr. Koziol and the Illinois MRF leadership, with an assist from investment consultant Callan Associates, have racked up an impressive average 5-year return of 5.4 percent for 2006-2010, net of investment expense. That’s better than the mighty Harvard Management Company did in the same period (4.7 percent), and I’m pretty sure Mr. Koziol wasn’t pulling down $4.8 million in 2009, like Jane Mandillo.

MRFI also beat out Brown (5.2 percent), Rice (5.1 percent), UTIMCO (4.4 percent), and Texas TRS (2.9 percent) per self-reported 5-year returns over the same period, all of whom were led by CIOs earning seven-figure compensation.

Enjoy your retirement, Mr. Koziol, you earned it.

… and Michael Walsh:

At Chicago’s Municipal Employees’ pension (MEABF), CIO James L. Mohler is moving up into the executive director spot, and the board has picked Michael Walsh as the new CIO of the $5.3 billion fund.

Mr. Walsh has worked at City Hall since 2005, most recently as Chicago’s Deputy Treasurer. Now he’s headed four blocks north to the MEABF offices.

The City’s funds are parked in fixed-income instruments and cash, so Mr. Walsh will have to get up to speed on equities and alternatives under Mr. Mohler’s tutelage. But he’s had previous dealings with the city pensions from the treasurer’s office, which manages some of their cash; and, obviously, he has the board’s confidence.

Mr. Walsh earned a BS in finance from University of Illinois and an MBA from Northwestern University’s Kellogg School.

David Kushner: From fog to smog:

David Kushner has just taken over as chief investment officer of the Los Angeles County ERA pension fund. He was recruited from his post as CIO of San Francisco ERS after ten years on the job.

I’ve had some good conversations with Dave while he worked here in San Francisco. He’s a bright, hardworking pro with a wry sense of humor and I think LACERA’s lucky to get him.

If you can survive the bizarre politics of San Francisco then you are ready to handle anything. My opinion only, of course. Dave is a discreet guy who sticks to his knitting, a fine quality in a public servant.

He’s taking over a $40 billion fund, which is a big move up for him from the $13 billion SFERS. He’s also following a very good investment manager, Lisa Mazzocco, who was lured away by the USC endowment to be their first CIO, and has had a busy summer setting up her new office.

I haven’t talked salary with Dave, but I have good reason to believe that he will be getting something north of $350 thousand base in his new job.

Before he arrived in California he managed equities for ING Investment Management in Atlanta and was a senior portfolio manager at Florida State Board of Administration. In between, he founded and ran his own investment advisory firm in the 90s.

He spoke to me last week as he was settling into his new digs in Pasadena.

Skorina: Dave, you’ve worked as both a for-profit money-manager and then a non-profit CIO. What are the big differences?

Kushner: Well, a public pension manager works in a fishbowl. For instance, the right time to hire an outside manager is often when their strategy is out of fashion. It’s just an extension of the basic buy-low, sell high imperative. There are times when a value strategy or a convertible-arbitrage strategy isn’t working. That’s when you might want to invest, anticipating that another cycle is coming and those strategies will start to work again. Unfortunately, some reporter will then announce that you’ve invested in a manager who has had a couple of “bad” years, so you’re obviously an idiot or corrupt, or something. They don’t understand how this business works, and they’re unwilling to be educated. So there you are, trying to figure out the future, which you can still control to some extent; while your critics are raking through the past, which is now history.

Skorina: So, how do you dodge those bullets?

Kushner: You make sure you have have a process and then stick to it. That’s why we have public RFPs, and a board that has to buy in, and an automatic rule for putting managers on a watch list, and so on. It gives you something to deflect at least the more irresponsible critics. My board in San Francisco has been very good, by the way, and I hope they feel the same way about me.

Skorina: Best of luck, Dave.

Kushner: Thanks, Charles; stop and see me when you’re down south.

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What We’re Reading:

Here are a couple of items which caught our eye last week and should interest our readers.

First, over at Bloomberg BusinessWeek, reporters Jonathan Keehner and Jason Kelly turned out a great feature on how the Texas Teachers pension (TRS) and other institutions are pushing back on private equity fees.

It’s “The People vs. Private Equity,” and you can read it here:

http://www.businessweek.com/printer/magazine/the-people-vs-private-equity-11232011.html

Why, they ask, since pension funds have always had all the money, did it take them so long to do this? They conclude that , for various reasons, institutional investors now have more leverage than they had in the past. And, if they’re lucky, they have someone like Steven LeBlanc.

Mr. LeBlanc, who runs a $35 billion PE allocation for TRS, is the protagonist of the piece. He started out as the CEO of a very successful real estate investment trust. So he’s been on the other side of the table as a general partner. When he butts heads with KKR and Apollo, it’s not a random collision; he knows what they know.

As the reporters note:

He approached the task with an edge that many pension managers, whose ranks are staffed largely by career public servants, didn’t have. “I’m probably a bit more aggressive than the average limited partner,” adds LeBlanc. “I’ve been a GP my whole career. That helps.”

Read the whole thing. Not only good reporting, but some entertaining prose.

Also, in the current Barron’s (dated 28 November), there’s a nice little piece which parallels the above, but focuses on hedge funds.

In “Pension Funds Strike Back,” reporter Jack Willoughby notes that:

“The pashas of the hedge-fund universe have failed to deliver that extra return for which they are so amply compensated, year in and year out. In the first nine months of this year, for example, the HFRI Equity (Total) index was down 5.3%, compared with a 1.3% gain for the S&P 500…Slowly, top pension funds are beginning to push back, insisting that hedge funds align fees more fairly with performance.”

Well, “fair” is always in the eye of the beholder and, as with the PE market, it depends on who has the leverage on a given day.

Mr. Willoughby reports a conversation with Larry Powell, Deputy CIO at the $20 billion Utah Retirement Systems. I’ve had some enlightening talks with Larry myself. He’s well-informed and can turn a phrase.

Larry and URS have been in the forefront of the push to better square fees with performance. As he tells Mr. Willoughby:

“I don’t think anyone is quite as aggressive as we have been. Even at the height of the hedge-fund mania in 2006 and 2007, I was negotiating and receiving concessions from managers on both fees and legal terms.”

Mr. Willoughby notes that institutions now represent almost 60 percent of the new investment in hedge funds, up from about 50% prior to the meltdown. Still, not all institutions are pushing hard.

As Larry Powell says:

“Unfortunately, many investors are performance chasers and rely almost exclusively on past performance, assuming it will persist in perpetuity…There are a lot of smart investors; however, there are a lot more dumb ones.”

He said it; I didn’t.

Unfortunately, the article is behind a pay-wall. But take a look if you have access.

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The view from Phoenix: A conversation with Paul Matson:

Paul Matson grew up in Edmonton, Alberta and earned his MBA at Vancouver’s Simon Fraser University in 1988. He went to work as a portfolio manager at the Alberta Treasury, dealing with the assets that were later spun off into AIMCO, the provincial sovereign-wealth fund. After two more years with Alberta’s Workers’ Compensation Board, he hung up his big, puffy, down parka and headed for balmy Phoenix, Arizona.

He served seven years as CIO of the Arizona State Retirement System, moving up into the executive director’s chair in 2003. ASRS assets have nearly tripled since he joined the system, from $10.5 billion to $30.5 billion.

In his spare time he earned a second master’s degree at Arizona State University, an MA in International Relations with a focus on international terrorism. I’m not surprised. The best investment managers I know are people like Paul with wide focus and deep curiosity.

I’ve enjoyed talking to Paul from time to time, and when I saw that the Arizona Capitol Times had recognized him for his contribution to the state in public policy, I decided to catch up on how the world looks from Phoenix.

Skorina: Paul, it says here that you’re one of Arizona’s Leaders of the Year. Pretty cool. So, congratulations. I also wanted to ask you about something that’s been on my mind about the relationship between size and performance in investment funds.

I always tended to assume that mega-funds were limited in their ability to outperform, but then I saw that Bridgewater, with close to $100 billion in total assets, had returned 25 percent so far this year. I think that’s pretty amazing, and I bring it up because I know you deal with Bridgewater.

Matson: Thanks, Charles. And, as for Bridgewater, yes those are excellent numbers. But, in all modesty, I should point out that we did about 25 percent this year, ourselves.

Note: ASRS return for the fiscal year ending 30 June, 2011 was 24.6 percent. See:

https://www.azasrs.gov/content/pdf/financials/
20110630_Total_Fund_Review_Q2.pdf

Skorina: So, you beat both Harvard and Yale! Congratulations again. OK, how did you do that? As I recall you run a pretty conservative portfolio.

Matson: Well, it’s true we have what many might consider boring allocations – roughly 40 percent US equities, 20 percent international equities, 26 percent fixed income, 7 percent private equity, 3 percent real estate, and about 4 percent cash and inflation-linked equivalents – but we take a tactical approach to our allocations. When we feel assets are mis-priced we take action. Our board gives us full authority to use our research and judgment.

Skorina: Can you give me some examples of what you mean when you say tactical?

Matson: Here’s one. After the 2008 meltdown our staff thought that equity prices were attractive. We decided to overweight them and we did it in a timely way. Last year we still thought stocks were relatively cheap. And, when long Treasuries rallied early in 2010, stocks were actually offering better yields than high-quality bonds. So, we stayed slightly overweight in domestic equities and it worked out. By the way, I think that equities are still pretty appealing; I’ll get back to that in a minute.

We also thought that credit spreads were wide and we should take advantage of them while we could, so we invested in some bank loans, floating-rate notes, and asset-backed loans.

One more point: We had very little exposure to real estate. Maybe that’s because we’re in the middle of the Sunbelt and had a front-row seat to the crazy run-up in land and building prices. We decided to stay away from them. It wasn’t a hard call, but it was a good one.

Skorina: That’s a good point , Paul: that your board gives you the latitude to hire and fire managers and tweak asset allocations without micro-managing your process. It looks more like what I see in the big Canadian pensions, where the board sets general policy and audits performance, but then leaves the driving to the pros. Could this have something to do with your Canadian roots?

Matson: I wouldn’t go that far, Charles. But I’ve been here for a while now, and the board has confidence in the investment staff. They’re also smart enough to know that the world is just moving too fast for management by quarterly review. In that sense, maybe you could say that our model is similar to some of the Canadian plans.

Skorina: Getting back to Bridgewater: You told me a while back that you have a few “strategic partners” including Bridgewater. What do you like about them?

Matson: We consider Bridgewater, Cargill, and Wellington to be strategic partners, not just investment managers. We like them for their research and immersion in the investment process. Take Bridgewater for example. They are data-driven and they have strong investment logic. I would say their research and investment logic is of academic caliber. We like Cargill because, really, who knows better what’s going on in certain commodities than one of the primary players in those markets? They have real-time intelligence that no one else can touch.

Skorina: I’m reminded of a conversation I had recently with someone who had worked at Koch Industries. They had a saying: “if you’re not part of the flow, you really don’t know.” Meaning that Koch, Cargill, ADM, and Glencore know more about what’s on the trucks, in the pipelines, and coming out of the mines than most CTAs. So they will always have an edge.

Matson: Exactly. And that’s why we sought out our partners.

Skorina: One more question, Paul. How do you size up then near future for investors? What are the big themes you’re thinking about?

Matson: A couple of things have our attention. First, on the positive side: As I mentioned earlier, I think equities are quite appealing at current prices. Many companies have strong balance sheets and their dividend yields are excellent. There are good stocks yielding nearly 3 percent in some cases. We think there are still good long-term opportunities there.

On the negative side: Of course, we’re watching the large European banks very closely and thinking about the implications for US investors should they collapse. Their true exposure to vulnerable sovereign debt is unclear. And, many US investors probably have higher exposures to European bank debt than they realize, through third-party investment firms. How can we protect ourselves? Or profit, for that matter?

Skorina: Paul, thanks for taking the time.

Matson: Glad to, Charles. And thanks again for the kind words