Farouki Majeed: A small pension finds happiness with a big-pension vet

Farouki Majeed, senior investment officer for asset allocation and risk management at the $235 billion CalPERS pension, has accepted a job as Director of Investments at the $10.2 billion Ohio School Employees Retirement System. He will be the fund’s senior investment officer, equivalent to a CIO. (Ohio SERS, for non-teacher school employees, is separate from the much larger $67 billion Ohio State Teachers Retirement System.)

Mr. Majeed was one of Russell Read’s last hires before Mr. Read left the CalPERS chief investment officer post in 2008. Mr. Majeed had previously been CIO of the Abu Dhabi Retirement Pensions and Benefits Fund, and also had a previous job in Ohio as deputy director of investments at the Ohio PERS pension in 2002-2004.

Insiders tell me that Mr. Majeed never quite got his footing at CalPERS and was also not happy with a rather modest bonus last year.

CalPERS had a good 2011, reporting net return of 20.9% for the fiscal year. So, we’d expect to see some respectable bonuses paid to the people who ran the money. According to the Los Angeles Times, CalPERS paid a total of $4.5 million in bonuses, averaging 41% of employee base pay.

We aren’t privy to the exact formula used in the CalPERS performance bonuses, but we presume they’re supposed to reflect the individual’s overall contribution as evaluated by the higher-ups.

There were four CalPERsons (including Mr. Majeed) with the rank of “senior investment officer” in 2011.

Eric Baggesen (global equities) got a bonus of 43% of his base pay, Curtis Ishii (fixed income) got 42%, and Ted Eliopoulos (real estate) got 37%.

Mr. Majeed’s bonus was just 14%. According to the L.A. Times, it was the lowest percentage bonus paid by CalPERS that year.

Performance-for-pay isn’t always pretty. The economist F. A. Hayek argued that the real role of prices is to carry information that helps individuals coordinate their plans and actions. CalPERS isn’t a free market, but pricing the work of managers like this does, indeed, convey information about what’s going on. It seems to have done so in this case.

Whatever the reasons for Mr. Majeed’s move, he seems to be just what Ohio SERS was looking for. Per their press release, this relatively small pension specifically wanted someone with big-pension experience, and CalPERS is the biggest we’ve got.

We don’t have a figure for the pay of retiring Ohio SERS Director of Investments Robert Cowman, but we note that John Lane, CIO of the much larger Ohio PERS pension ($76.5 billion AUM) made about $340 thousand in 2009, so Mr. Cowman almost certainly made much less than that. Mr. Majeed’s total comp at CalPERS in 2011 was $391,510.74.

Mr. Majeed earned an engineering degree from the University of Sri Lanka, an MBA in finance from Rutgers University, and is a CFA Charterholder. He’ll take up his new post in Columbus, Ohio in July.

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Scott Malpass: Joining the Vanguard

Scott C. Malpass, CIO of the $7 billion Notre Dame University endowment, has been elected to the board of Vanguard Group (including a seat on each of the Vanguard mutual funds).

Mr. Malpass has racked up an enviable 12.1 percent annualized return over 15 years at Notre Dame, putting him among the very best in the business.

Vanguard is, as Emerson would have put it, the lengthened shadow of one man, the remarkable John Bogle, who virtually invented the low-cost indexed mutual fund. Then, in the teeth of general indifference and ridicule, he created an engine to sell them to ordinary investors.

Nobel laureate Paul Samuelson, who taught freshman econ to Mr. Bogle back at Princeton, once said:

“I rank this Bogle invention along with the invention of the wheel, the alphabet, Gutenberg printing, and wine and cheese: a mutual fund that never made Bogle rich but elevated the long term returns of mutual fund owners.”

Mr. Malpass is joining a relatively small and very distinguished board currently including such luminaries as University of Pennsylvania president Amy Guttman, and HighVista Strategies CIO (and retired Harvard professor) Andre F. Perold, as well as Vanguard CEO William McNabb.

Along with Mr. Malpass, IBM CFO Mark Loughridge, (a University of Chicago MBA!), will also be joining the board as a new member.

A lot of American financial institutions have let a lot of people down in recent years, but Vanguard wasn’t one of them. We recall, for instance, the smelly mutual-fund scandals of 2003 when we learned that some large investors were allowed to trade after-hours to their advantage, while hurting the remaining investors. Several name-brand mutual fund managers were implicated. One of them, giant Janus Capital, for instance, went through five CEOs in one decade, lost many of its best managers and a ton of reputation. But Vanguard’s skirts were conspicuously clean.

Neither Mr. Bogle nor the leaders who came after him would have tolerated that kind of thing for a moment, and they have the kind of corporate governance that transmits those values to the troops. That’s why Vanguard is still trusted, admired, and making money for its clients, while many other financial players…aren’t.

Mr. Malpass should be a good fit at a good company.

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A conversation with Peter Stein:

Peter D. A. Stein was chief investment officer for the University of Chicago (2005 to 2009), and previously a managing director at the Princeton University Investment Company (2000-2005).

He recently completed an assignment with the Pacific Alternative Asset Management Company (PAAMCO), where he led strategic allocation for a $10 billion fund of hedge funds.

Mr. Stein serves on the investment committees of The Annenberg Foundation and the Rhode Island School of Design (RISD). He earned a BS in mathematics from Brown University and is CFA Charterholder.

Skorina:

Peter, as a Chicago grad myself, it’s always good to talk to you. You’ve gone from Wall Street to the Princeton and Chicago endowments, then to a big southern California fund of funds. Now here we are just around the corner from each other in downtown San Francisco as you start up a new CIO-outsourcing effort with the Presidio Group. So, you’re sort of back in the endowment world again.

You’ve really touched all the bases, so let me ask you my favorite easy question: What one big thing have you learned from your investment career so far?

Stein:

Well, more than one thing, I hope!

But, one big thing would be that, back in my endowment days, before the 08/09 crash, we were always talking to the rest of our colleagues in the university about their institutional spending needs and cash requirements, however, in big university systems it takes time to develop consensus and get buy-in.

Endowment and foundation investment offices are there to generate returns, not to set spending requirements; but it’s all related. Each institution has specific needs and risk characteristics. Some were looking to the endowment for 20% to 25% of their yearly budget; some needed much less. But the big ones were all moving towards the same kind of portfolios: complex asset allocations with lots of alternatives to reap the “illiquidity premium”.

And, let’s not forget that universities, in particular, are very competitive. They compete against each other on many fronts, for many things. They compete for the best students, the best faculty, and the biggest research grants; and, of course, for winning athletic programs.

Skorina:

That’s right. People forget that University of Chicago has an actual football team, sort of. The mighty Maroons, the terror of Division III!

Stein:

Absolutely, Charles. After all, somebody has to play Carnegie Mellon!

Skorina:

Sad, but true.

Stein:

Every leader wants his institution to move up in the pecking order. What could be more American? So, it seemed only natural that an endowment should compete for returns against its peers.

We all worked hard to maximize returns, but many endowments, including mine, were also beginning to reduce risk and build a safety cushion when 2008 came along.

It’s like when one of Ernest Hemingway’s characters asked somebody: “How did you go broke?” The other guy responded: “Two ways. First gradually, then suddenly.” Big institutional portfolios just cannot turn on a dime.

Skorina:

Are you saying, and I hate to use the cliché, but here goes: that the “endowment model” really is broken?

Stein:

No; in fact, quite the opposite. Significant allocations to non-traditional assets such as absolute return, private equity and real estate are appropriate for most long-term institutional investors. But that doesn’t mean every one of them should be taking on the same level of liquidity risk as Yale. Diversification has to be tailored to the needs of each specific investor.

When I talk to institutions and investors, I sum it up this way: an institution may have a long time horizon, but it’s made of people with very short time horizons.

And given what we’ve been through, the virtues of maintaining an extra level of liquidity are now, perhaps, better appreciated.

After all, market crashes and liquidity squeezes like the one we experienced a few years ago have happened many times in history and will surely happen again. So we need to keep that in mind as we calibrate the investment requirements of each client, whether university or foundation.

For example, Mark Schmid, my successor at the University of Chicago endowment, has done a good job of looking at the entire universe in which the endowment operates and how different scenarios can impact the university and the endowment.

In fact, I believe, Charles, you were the one who pointed me to the excellent paper Mark and his Chicago team wrote about their “total enterprise” approach to managing the investment. It really explains how all the parts fit together.

[CAS comment: We've posted that paper on our website, front page center, under "People in the News", and I highly recommend it.

See www.charlesskorina.com/ A Total Enterprise Approach to Endowment Management. It's co-authored by Mr. Schmid and Que Nguyen, his Managing Director of Strategy.]

Skorina:

You recently spent some time at PAAMCO, one of the biggest fund of hedge funds managers. How has that shaped your outlook?

Stein:

My time at PAAMCO has directly affected the way I’m looking at my new business as an outsourcer for mid-sized endowments.

PAAMCO was not offering a one-size-fits-all product. They focus very strongly on the specific and unique needs of each client and the importance of providing a custom solution. That’s how the fund of fund industry is evolving, and that’s how the outsourced CIO model must evolve.

It goes back to the lessons I cited above. Each institution has different cash needs, different debt-service pressures, different levels of dependence on the endowment, different flows of support from donors. And finally, each board is different; some can live with more risk than others.

And, since each institution tends to operate in its own little bubble, they may not even understand, themselves, how different they are from each other. An outside firm with a wider perspective can often see things they can’t see themselves.

The only way an outsourced investment office can succeed is by understanding those differences and the implications they have for constructing and managing a portfolio.

I’ve spoken at a lot of development events and listened to many donors and trustees, with the emphasis on “listen”. They are seldom shy about expressing themselves.

With the help of Presidio Group, we are going to offer a best-of-class outsourced investment office. We are going to do it step by step, scale it properly, and do it with superior execution. We will report directly to the client’s board, just as an internal office would do, but offer a level of management excellence that our target institutions could not otherwise afford.

Skorina:

One last thing, Peter: We’re doing some investment office cost studies (which we’ll be talking about soon in our newsletter), and looking generally at the drivers of investment management costs and the implications for boards and CIOs. As a former CIO, and now an outsourcer, how do you think about managing those costs?

Stein:

When we evaluated external managers we always thought about whether their fees made sense relative to the specific strategy they were offering.

I always told my people that I would rather have high returns net of high fees, than low returns net of low fees.

Of course, you want low fees as a general proposition. But it isn’t always smart to squeeze too hard on any specific manager. You have to understand what he’s doing and how his strategy scales. Push back too hard on fees and you can force them to make it up by taking on too much capacity; perhaps more than the strategy or staff can handle.

Fees and costs should always be a consideration, but not the determining factor. Each piece of the portfolio has to be cost-effective in its own way, on its own terms.

As an outsourcer, this concern with return vs. cost translates into an open-architecture approach, meeting the client’s specific needs with maximum transparency. No black boxes. Institutions should demand nothing less from an outsourcer, and it’s what we intend to deliver.

Skorina:

Thanks so much for your time, Peter. Good luck with your start up, and welcome to San Francisco!

Stein:

Thanks, Charles, it was great talking to you.

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New views from a strategist and a tactician:

In the old paradigm, 90 percent of the risk was allocated to equity, so a lot of time was spent trying to generate incremental return relative to the equity benchmarks. This was analogous to a search for mathematical models placing the Earth back at the center of the universe.

- Michael Litt, Chief Investment Officer, Arrowhawk Capital Management

Every CIO I speak with is talking about risk, but I don’t know of one endowment, foundation, or pension fund that has actually implemented a portfolio risk system or is using one to manage their money.

- Bill Ferrell, Ferrell Capital Management

Two very knowledgeable guys – Michael Litt and Bill Ferrell – recently gave me a peek at draft white papers they’re preparing. And, although they’re the product of two independent thinkers, I was struck by how they intersected with regard to risk management.

A whole new generation recently had to learn that risk isn’t just a number. It can leave you standing out on the curb in front of Lehman Brothers with your handball trophies in a cardboard box and no particular place to go. Then risk gets a whole strange new respect.

Both Michael and Bill argue that most institutional investors are still not dealing adequately with risk; i.e., they’re not earning the best risk-adjusted returns possible with the capital that’s been entrusted to them.

Michael is a fellow Chicago MBA who led the corporate pensions group at Morgan Stanley before he jumped to hedge fund management, first at FrontPoint, then with his own Arrowhawk Capital. He’s adopted the risk-parity approach to asset allocation (with certain variations on the theme) and in his paper explains why he thinks it’s no less than a Copernican revolution in portfolio design.

Bill was a trader at CitiBank when the Value At Risk (VaR) technique was being invented there, then went out on his own to found Ferrell Concert Fund. He also offers risk control services to institutional investors using a proprietary approach to tactical, real-time risk-mitigation. In his paper he focuses on how to actively control risk within existing allocations (whether they’re Copernican or Ptolemaic, from Michael’s point of view!)

Two different perspectives: one is strategic, one is tactical. But, they’re more complementary than contradictory, and both are worth hearing.

Michael, in his draft paper Money for Nothing, Growth for Free, argues that most institutions still use a capital-based approach to asset allocation, ultimately driven by their target returns. He says this is a paradigm that needs to be up-ended.

Of course, funds have to relate current assets to future liabilities, and this implies a minimum required rate of return. But letting this number drive the whole investment process may be a “fatal error” if it’s applied to a fundamentally flawed asset allocation. This process, he says, won’t get you where you want to go if your allocation is already too equity-heavy. We need to flip this picture the way Copernicus overturned the Earth-centered world of the Middle Ages, and start with risk-budgeting.

A 60/40 portfolio is still the benchmark for most institutional portfolios. But, he says: “A 60/40 allocation implies structural superiority for the risk-adjusted returns of equities, yet the opposite has been true on average over the past 85 years.”

He cites research showing that stocks have historically generated 90 percent of the risk in a 60/40 portfolio. But what if the return from those stocks hasn’t justified that risk? Trying to hit a required return with a fundamentally suboptimal allocation gets everything backward. Michael says we need a Copernican revolution in portfolio allocation that gets rid of the 60/40 myth before we think about what returns are attainable.

He again cites recent research to support his argument.

For example: Asness, Frazzini and Pederson in 2011 mined the CRSP database and concluded that for the past 85 years the SML (Securities Market Line) has had a flatter slope than predicted by the Capital Asset Pricing Model. This implies that bonds have had better risk-adjusted returns than stocks, even if “market efficiency” predicts otherwise.

This leads back to the same conclusion: traditional portfolios are over-weighted to stocks and therefore aren’t really optimal, even if standard mean-variance algorithms say they are.

The Asness paper claims to fill an explanatory hole in the previous case for Risk Parity. That too-flat SML line is the result of past manager who couldn’t – or at least didn’t – just lever up their bond portfolios to get better overall risk-adjusted returns. Asness, et al say it’s because of “leverage aversion” on the part of investors: institutions have been culturally allergic to such “borrowing.”

The Asness paper is online, here:

http://pages.stern.nyu.edu/~lpederse/papers/LeverageAversionRP.pdf

Michael has picked up the Asness ball and run with it. His new paradigm depends on boards and CIOs who can shed that leverage-aversion.

Ease those constraints, and maybe you can get to a portfolio that is actually more efficient than the ones generated by traditional approaches.

There’s more in Michael’s paper about all the implications of his new paradigm going forward, but I think that’s the gist of it.

Now, some very smart people think risk-budgeted portfolio construction (i.e., Risk Parity) is the way to go; and other very smart people disagree.

Of course, there’s a big difference between risk-budgeting as a philosophy at the portfolio-construction level (per Michael Litt ), and the specific risk-parity products being offered by various vendors. Those RP-advocates include such distinguished folk as Dr. Cliff Asness, who is the lead author of that study cited above. Dr. Asness, wearing his CEO hat, also builds risk-parity products for institutional customers in his AQR Capital shop.

By way of visiting these contrary views, take a look, for instance, at these board minutes from October, 2010; as CIO Gary Dokes and his Arizona Retirement System board debate and then shoot down NEPC’s risk-parity proposal with a 4-to-zero vote after some very thoughtful discussion. See:

https://www.azasrs.gov/content/pdf/minutes/20101012-ic.pdf

On the other hand, Pensions & Investments announced not long ago that Pennsylvania SERS is allocating 5 percent of AUM to a risk-parity strategy. It will go into the All Weather Fund of Bridgewater, the grand-daddy of risk-parity vendors. See:

http://www.pionline.com/article/20120312/DAILYREG/120319987

And so it goes. But, between the theoreticians and marketers, Michael’s new paradigm might yet emerge in some fashion.

According to Bill Ferrell, most CIOs do not actively manage risk because most investment boards and managers are still asset-allocators. They believe that the only risk that matters in equities is the risk that they will miss a benchmark return.

And, as a headhunter focused on the pay and incentives of investment managers, I note that most bonuses are firmly anchored to benchmark-related returns, not to risk-based measures.

“But who is managing the risk of the benchmarks?” asks Bill Ferrell.

“No prudent investor would add an investment to his portfolio if that investment exhibited historical or implied volatility of 40%. So why would anyone want to hold the S&P 500 when the VIX soared above 70% in 2008?”

Risk managers, as opposed to return-chasers and benchmark-huggers, focus on changes in the internal components of risk that represent the greatest threats to stability. And those components are the volatilities and correlations within portfolio allocations.

They are aware that, during periods of stress, equity-oriented and higher-risk bond assets tend to become more negatively-correlated to low-risk bonds. In practice, this means that there is a “flight to quality.” Low-risk bonds often generate positive returns in those situations.

Whether you go at it strategically or tactically, or both, Michael and Bill agree that there are still under-used tools available to boards and CIOs which could improve risk-adjusted returns, reduce overall volatility, and don’t depend on the arcane art of superior manager-picking. They converge on the idea that you manage risk, not capital, and that risk should be managed dynamically, not statically.

From Motown to Chocolatetown – Eric Henry gets a sweet deal at the Hershey endowment:

Eric Henry, startup chief investment officer for the $55 billion UAW Retiree Medical Benefits Trust in Michigan, has been hired as CEO and CIO of the Hershey Trust Company in Hershey, Pennsylvania, which invests about $8.5 billion of charitable capital.

It’s a good move for Mr. Henry, whose 2010 salary in Michigan was $499,332. The Hershey job paid the previous CIO $948,424, and will presumably pay Mr. Henry as much or more, given that he will also get the CEO hat.

Mr. Henry’s successful and peripatetic career has taken him full circle: from Pennsylvania, to New Hampshire, to Pennsylvania (again), to Texas, to Michigan; and now back to Pennsylvania, still again. In Hershey he will be just a stone’s-throw from Harrisburg where he previously served as executive director at the Pennsylvania SERS pension.

The UAW trust holds the funds for a so-called VEBA (Voluntary Employee Benefit Association), which pays health benefits for retired auto workers. It was spawned by the massive federal bailout of the Detroit automakers in 2008/2009.

Bankrupt GM and Chrysler and not-quite-bankrupt Ford needed to offload their retiree medical liabilities from their own cratered balance sheets. A complex, high-stakes negotiation between companies, unions and the Feds midwifed the VEBA, which opened its doors in Ann Arbor in January, 2010. To fund those liabilities, the trust got company stock, some cash, and other odds and ends.

The new board, following recommendations by Hewitt EnnisKnupp, wanted a portfolio that was both more conservative and more liquid than what they were originally handed. The man they hired to set up an investment office and execute the plan was Eric Henry, a veteran institutional investment hand they hired away from a public pension in Texas.

He’s taken some notable steps to unload some of those legacy assets. Last March, for instance, he found a window in which to sell a bushel of Ford stock warrants that were on their books at $360 million; a one-day auction raised $1.8 billion for the trust. Ford stock was then at $13.50, up from just $2 in 2009. That made the warrants with their $9.20 per share striking price an attractive speculation at $5.

Presumably most were bought by hedge funds and, if they were clever enough to sell at the market peak early this year, they could have almost doubled their investment in 10 months.

Mr. Henry had faced a different kind of portfolio makeover job when he was hired by the Texas MRS pension in 2007. MRS, a defined-contribution plan, had been invested almost entirely in bonds and he was tasked to diversify them into a more conventional multi-asset portfolio. He seems to have made a good start in his two-year stint as executive director and CIO.

When he arrived in Austin in 2007, the $15 billion pension was 98 percent invested in fixed-income; by the end of 2009, he had worked it down to just 66 percent. It was fortunate for all involved that they didn’t diversify any faster or earlier; sitting on a lot of Treasuries, cash, and high-quality bonds was exactly where you wanted to be in 2008. Ironically, that allocation he’d been hired to undo saved their bacon. Mr. Henry could point back to an average 3-year return of 5.9 percent as of 2010, way better than most of their more-diversified peers. Timing is everything.

Mr. Henry will now be investing the endowment of the Hershey charities, which was seeded in 1909 when Milton Hershey donated 486 acres of land and $60 million in Hershey stock to start a boarding school for poor children. Most of the money is housed in the Milton Hershey School Trust, but that fund is steered by the Hershey Trust Company, a subsidiary which houses the investment staff.

Mr. Hershey weaved a tangled web when he set up his charities and gave them control of the chocolate company, but it seems to have worked as intended. Anyone who’s interested can consult the convoluted org chart here:

http://www.hersheytrust.com/hershey_heritage_trusts/hershey_entities/organization_chart.php

So, Mr. Henry now faces still another un-diversified portfolio, but no one will be expecting him to change that anytime soon. About three-quarters of the Trust’s assets consist of Hershey Company stock. Despite occasional talk about mergers over the past decade, the board of the Trust has consistently tried to maintain control of the chocolate company. We note that the stock price has doubled over the last ten years since all of those “missed” M&A opportunities passed by; so maybe they weren’t so dumb, after all.

The Trust Company is chaired by Mr. Henry’s new boss, Robert Cavanaugh, who stepped up to that job only three months ago. Mr. Cavanaugh is a finance guy himself, a Hershey School graduate with a Harvard MBA.

Although the Hershey Company has its own board, the Trust ultimately controls the chocolate company (with 80 percent of its voting power and 30 percent of its common shares). But that still leaves about $2 billion in publicly-traded non-Hershey assets to deploy in support of the charities, enough to keep Mr. Henry and his staff busy.

It’s striking how often Mr. Henry has held a combined CEO/CIO job. He had that arrangement at the New Hampshire Retirement System (2000-2004), and at Texas MRS (2007-2008). (Since he left, MRS has split the job between two individuals.)

He was just plain executive director at Penn SERS 2004-2007, but is now a double-hat CEO/CIO again at Hershey. He is clearly a full-service manager with a broader skill-set than your average CIO.

I note that he didn’t start as a portfolio manager, either. He was chief of internal audit (and assistant executive director) at Penn SERS (1994-2000). After his 4-year excursion with the $5 billion New Hampshire pension, he was back in Harrisburg, picked for the top job at Penn SERS. In addition to a CPA, he holds a tech-heavy CISA (Certified Information Systems Auditor) ticket.

Mr. Henry earned an accounting degree from Penn State and an MBA at Bucknell University. Being unmarried seems to have made it a little easier for him to negotiate frequent career-moves. I’m told however, that his two loyal dogs accompany him in all his travels.

He/she must excel at both:

1. Driving a hedge fund selection process and assembling custom hedge fund portfolios, and…

2. Outstanding client-service management and communication.

The right candidate – probably the current head of research or senior member at a large fund of funds – will be snapped up by my client: a multi-billion AUM money manager in the Mid-Atlantic area. The role is a new position reporting directly to the CEO, with a seat on the investment committee.

Compensation will be highly competitive.

Please call or email me: Charles A. Skorina (415-391-3431) skorina@sbcglobal.net

Rick (Humphrey Bogart): I came to Casablanca for the waters.

Captain Renault (Claude Rains): The waters? What waters? We’re in the desert!

Rick: I was misinformed.

In his new book – The Hedge Fund Mirage – Simon Lack contends that most hedge fund investors came looking for the waters, but were sadly misinformed. They swarmed into hedge funds based on the excellent historical returns reported by fund managers and industry indexes, but found themselves in a desert of low returns. Those historical numbers, he argues, are fatally flawed.

Our faithful readers may have already have seen Mr. Lack’s core argument. Way back in Skorina Letter 21 we linked to his 2010 article in AR Magazine: Hedge Fund IRR Has Been Pathetic, along with a link to an academic paper (Dichev and Yu, Higher Risk, Lower Returns: What Hedge Fund Investors Really Earn [2009]), which supports his views. If you want the short version, we can save you $34.95 on the book purchase by steering you to that AR piece here:

http://www.absolutereturn-alpha.com/Article/2728122/Hedge-fund-IRR-has-been-pathetic-Magazine-Version.html

Here’s an even shorter short version of Mr. Lack’s thesis:

The hedge fund industry grew very fast, from $130 billion in 1998 to $1.6 trillion in 2010 (with a pre-crunch peak at $1.9 trillion in 2007). But if an investor looks at a time-series of an industry index, or the growth enjoyed by a first-dollar investor over ten or fifteen years in a given fund, he will see a number that is not adjusted for that huge fifteen-fold increase in industry AUM.

For instance, the HFR Global Hedge Fund Index (HFRX), using returns from 1998 to 2010, says the HF industry has had an average annual return of 7.3 percent. Compare that to other major asset categories over the same period (5.9 percent for the S&P 500, 3.0 percent for T-bills, and 7.2 percent for corporate debt), figure in the benefit of the vaunted non-correlation offered by hedged “absolute return” strategies, and it all looks pretty darn good. Who wouldn’t want to get some of that?

This is where the mirage lurks, according to Mr. Lack. Returns in those early years were generally higher; returns in the later years were lower. If you adjust each year’s returns by the steadily-rising industry AUM, you get a completely different story. On this basis, funds have returned a paltry 2.1 percent. The average investor got into bigger funds later in the period, and the average dollar deployed by that average investor earned closer to 2 percent than 7 percent. In other words, the average return to the average investor in his average holding period was, as Mr. Lack puts it, pathetic.

As we note above, T-bills earned 3.0 percent in that period. If HFs “really” returned only 2.1 percent for the typical investor, then you would have been better off buying treasuries without paying 2-and-20. Or, maybe you should have just tried your luck on the crooked roulette wheel in the back room of Rick’s Café.

Of course, he hastens to add:

…saying that hedge fund investors in aggregate have done poorly isn’t the same as saying everybody’s lost money… However, most of us assumed that the average in this case was pretty good, whereas it turns out to be pretty poor.

In math-speak, what Mr. Lack is proposing is that hedge funds and the indexes report an internal rate of return (IRR), or asset-weighted return. We should do this not just to make hedge funds look bad, but because it makes sense.

Mutual funds don’t report IRR; their literature touts first-dollar-invested returns. But that’s OK, because mutual fund managers have no control over the ebb and flow of investor money. But a hedge fund is more like a private equity or real estate vehicle. They can all (more or less) accept or refuse capital and deploy it on their own schedule. Real estate and PE managers report returns on an IRR basis, says Mr. Lack, and so should hedge funds, notwithstanding current industry practice.

In the good old days not only was total industry AUM much smaller, but the average hedge fund was itself much smaller. Mr. Lack firmly believes that smaller funds perform better, and that this is the root cause for declining returns. This is a controversial point, of course. Some studies support small-is-better; some don’t.

There is much more, of course, as there would have to be when you’ve expanding a 700-word article into a 200-page book. There are war stories about how he didn’t invest with Bernie Madoff or with Long Term Capital Management, and some hyper-technical stuff about hedge fund accounting just to show he knows whereof he writes.

Captain Renault: I’m shocked, shocked to find that gambling is going on in here!

Croupier: Your winnings, sir.

Captain Renault: [sotto voce] Oh, thank you very much.

Mr. Lack delivers a fairly shocking analysis (if you’re easily shocked) of how much of the total profits went to the GPs rather than the LPs. But, it doesn’t seem to us that it’s directly germane to investors. If they were earning handsome returns themselves, they might be indifferent to the even handsomer returns to the fund managers. Since they’re not, the enormous profits going to the managers, once revealed, might trigger pangs of envy.

Given the wide attention this book has received, the HF industry and its superstars might be well-advised to have a rebuttal ready. And, if someone out there has one, we’d be happy to print it, or link to it.

When a debunking book like this appears, we naturally wonder about the author’s motives and bona fides. Is he a crank, or a Marxist professor who hates capitalism? Here: no and no.

He came to the U.S. from Britain in 1982 as an FX and debt trader and, through a circuitous route, wound up on the investment committee in charge of finding hedge fund investments for JPMorgan’s elite private banking customers. Specifically, they were seed investors in small funds, one of the first, and a lot of their returns were from sharing in the fee income of their portfolio. In effect, they were venture capitalists in the young hedge fund industry, and did very well at it.

He retired in 2009, and now runs SL Advisors, which advises separately-managed accounts and claims to offer investors all the features which he looked for when he was seed-investing for JPM.

See: http://www.sl-advisors.com/about-us.html

Mr. Lack admires the star hedge fund managers and isn’t accusing anyone of deliberate deception. Rather, he thinks that most of the investors piling into hedge funds have not been operating at the level of JPM’s private bankers.

Investors are all voluntary clients. Hedge funds are meeting a clear demand from the market. And the vast majority of capital is provided by “qualified” investors, either individuals … deemed “sophisticated” or institutions fully capable of accurate analysis. The fact that it hasn’t turned out well is very largely the fault of the investors themselves.

Mr. Lack and his colleagues were super-picky investors who kissed a lot of frogs in those years.

He proudly says:

…we maintained our investment criteria at a consistent standard throughout. As a result, we ran out of compelling places to invest our capital, and by 2006 we told our clients we wouldn’t be deploying their remaining capital and would be returning what we had.

Well, this is all very well, but what is the actionable moral for the rest of us: say, a pension-fund manager?

If you’re going to invest based on looking back at history, invest in something that looks like the history you’re looking at.

In other words, those early returns are ancient history.

Trustees of pension funds, and others in a fiduciary role, should be far more skeptical…

Skepticism is good, but it isn’t a plan. How exactly does he propose that we (meaning you) should invest in those small funds, assuming you don’t just give up and buy T-bills?

You should do it the way his super-smart unit at JPM did it:

A large investor negotiating with a small hedge fund might obtain a separately managed account… Even if that’s not possible, the investor can demand complete daily position, transparency, delivered directly from the custodian or prime broke….

The investor can probably negotiate more attractive fees, perhaps improved liquidity terms, and maybe even a stake in the business if they’re one of the early investors and want to become a seed investor… if the fund does turn out to be a winner, the ownership of the business can turn out to be more lucrative than the investment in the fund.

Oh, and there’s this:

The only way to successfully invest in hedge funds is to be above average at manager selection.

Well, there’s the problem, right there. You’ve only been average manager-selectors, and you should have been above-average! What were you thinking?

Your board and your consultants are probably more risk-averse than JPM’s private banking clients. They want to see funds with sophisticated risk-systems, operational security, long track-records, substantial capital, etc, etc. But these are exactly not the kind of lean-and-hungry startups that made money for Mr. Lack’s team at JPM.

Also, he regrets to tell you that you just may not be smart enough. He postulates that there is a Hedge Fund IQ and, like regular IQ, it is not fairly distributed. In his polite, English way, he lets you know just where you stand in the pecking order. From top to bottom the HF IQ ranking would be:

1. Hedge fund managers

2. Traders who trade with or against the HFs

3. Hedge funds of funds

4. Consultants who advise institutions

5. Trustees and investment committees of institutions

Hedge fund investors need to acknowledge that they are unequal partners with their chosen managers and pursue negotiating strategies that compensate, or invest elsewhere.

If you buy Mr. Lack’s analysis you may not have a usable plan for hedge-fund investing, but at least you’ll have a better notion of what you’re up against.

Onward and upward with Shawn Wischmeier: Latest move makes him CIO of $6 billion US foundation:

Shawn Wischmeier, who has been chief investment officer of the $72 billion North Carolina Retirement System for just 19 months, has resigned to become CIO of the Margaret A. Cargill Philanthropies in Minnesota. Recently augmented by an inheritance, this group of foundations is currently valued at about $6 billion.

Mr. Wischmeier’s new salary was not announced, but CIOs at other top private foundations with more than $5 billion AUM typically pull down between $700 thousand and $2 million.

North Carolina Treasurer Jane Cowell announced on February 17th that he will be leaving Raleigh as of March 2nd.

In his new job Mr. Wischmeier will manage the assets of the Anne Ray Charitable Trust, the Margaret A. Cargill Foundation, and the Akaloa Resource Foundation. With a recent windfall from the estate of Margaret A. Cargill, they are now collectively one of the top ten American Foundations, comparable in size to the Packard, MacArthur, and Pew Foundations. Ms. Cargill, who died in 2006, was one of the eight heirs to the Cargill grain-trading fortune.

The Margaret A. Cargill Philanthropies are led by Christine Morse, and Mr. Wischmeier is only her latest acquisition. Anticipating the windfall, she’s added 30 new staff-members over the past year, with more to come.

Ms. Morse was a financial executive at Cargill Corporation before going to work at the family office, where she met Ms. Cargill. She is currently CEO and co-CIO of the Margaret A. Cargill Foundation. She and co-CIO Paul Busch earned $589,732 and $535,409, respectively in 2010, when the foundation had assets of only $1.97 billion.

Two short years ago, as CIO of the PERF pension in Indiana, Mr. Wischmeier made $126 thousand. Arriving in North Carolina in 2010, he doubled that to $320 thousand, with the possibility of annual bonuses up to 15%. Now, at Cargill Philanthropies, even at the low end among his peers, he will likely double his comp still again, making at least $650 thousand, and quite possibly over $1 million.

Mr. Wischmeier has two engineering degrees plus an MBA from Northwestern University/Kellogg. He came up through the Global Treasury Group at Eli Lilly before getting his first CIO position at Indiana PERF in 2006.

Mr. Ailman weighs in for us:

This is where we’d usually say something about low salaries at public pensions making stepping stones to bigger jobs for their best talent. But Christopher J. Ailman, the redoubtable CIO of California’s CalSTRS pension, beat us to it. He posted a comment at the Pensions & Investments website just fifteen minutes after P&I flashed the Wischmeier resignation on Friday. (At least, we presume that poster “C. J. Ailman” is that C. J. Ailman.)

He wrote:

Congrats Shawn! He is a rising star among CIO’s the public funds lose yet another quality CIO. Until there is a modicum of balance in compensation between Endowments, Family Offices and Public Pensions, the Public funds are going to continue to be a stepping stone. It’s a sad state for institutions that are so critical to some many people, pensioners, members, and the taxpayers. I guess they are the equivalent of small market sports teams. Bit of an irony that they are in fact the large money, yet hey are forced by their environment to operate with a small market business philosophy.

We couldn’t have put it more pithily. So, thanks for the guest editorial, Mr. Ailman. We owe you one.

Cheers and jeers:

Many readers and several industry publications commented on our CIO performance-for-pay analysis in Skorina Letter 35. Most of you liked it; some others, not so much. But everyone was civil and we appreciate all the feedback.

The original report is available on our website, here:

http://www.charlesskorina.com/

And, here are links to what others had to say:

http://ai-cio.com/channel/NEWSMAKERS/New_Findings_Question_Value_of_Harvard,_Other_CIOs.html

http://www.ai-cio.com/channel/DEALS/Ambachtsheer__Pension_Fund_Manager_Compensation_Should_Be_Reevaluated.html

http://www.top1000funds.com/news/2012/01/27/do-you-get-what-you-pay-for/

http://www.top1000funds.com/insider/2012/01/27/how-to-tackle-the-appropriate-pay-structure/

http://www.efinancialnews.com/story/2012-01-23/cios-ranked-on-their-bang-for-buck

If you’re arriving late, here’s the short version:

We took our list of the 50 highest-paid non-profit CIOs and checked their investment returns for the five years 2006-2010. We divided that five-year return by their most recent compensation (i.e., basis points per $100K of comp). Then we ranked them by that performance-for-pay statistic.

The rankings were surprising. Some brand-name CIOs, including David Swensen at Yale and Jane Mendillo at Harvard ranked near the bottom. Some less well-known CIOs, with good returns but relatively modest comps, appeared to be much more cost-effective and ranked higher on our list.

We can’t respond to all the criticisms (or acknowledge all the compliments!) in detail, but we’d like to make some general comments about the uses and misuses of our findings.

But we’re special?

Most objections were variants on the same theme: performance of a fund (and compensation of people hired to manage it) should be judged by internal criteria. Peer-performance, they say, is irrelevant because every institution regards itself as peerless. And absolute investment return doesn’t matter; only the specific targets set by the organization.

For instance, did the portfolio provide income that held up its end of the institutional budget, while maintaining the corpus and adequate liquidity? Or, did the allocations stay in step with the policy portfolio; and did returns hit their benchmarks? Or, did the risk incurred by the CIO match the expectations of the board?

From this point of view whatever an institution chooses to pay its CIO is the “right” amount. Only the board is in a position to judge whether CIO performance is satisfactory, using their own specific standards.

CIO pay, then, may just be what economists call a “revealed” preference. It may not be the “right” price based on some abstract utilitarian rule like maximizing performance-for-pay. But the real world doesn’t always play by utilitarian rules, and boards operate with information, constraints, and goals which may be invisible to outsiders.

Insiders and outsiders:

Our response to these very good points is: External criteria can comfortably coexist with internal criteria.

Like it or not, all of these funds — even the “private” foundations, endowments, and charities — are tax-exempt only at the sufferance of state and federal legislatures, which means ultimately the citizens. And they are all important players in the economy as allocators of capital.

Funds are scrutinized by outsiders who want to know how they perform their missions and manage their resources. That includes people like me who try to understand the job market for investment managers. Inevitably, funds and their leaders will be compared to their peers on various dimensions, even if they would really rather not be.

Outsiders aren’t privy to everything the board and investment office know. They need objective, transparent criteria to help them understand what’s going on at specific institutions and in the market for investment talent generally. We think our performance-for-pay ranking is a useful tool for those outsiders; and maybe some insiders, too.

Some readers objected that our measurement could be misinterpreted and taken out of context. That’s certainly possible. But we provided all the supporting data and we think people can make their own inferences.

An analogy: Investors use a myriad of data and ratios to help them make decisions. The price-earnings ratio of a stock, for instance, is useful information; but only an idiot would buy or sell a stock based solely on its PE. We trust that our readers are not idiots.

Apples, oranges, and short-timers:

Several readers pointed out that our rankings included a few CIOs who were not on the job for the full five years 2006 – 2010.

We prominently included the start date of each CIO, and even highlighted the names of those who were aboard for less than three years. We thought this was sufficient warning.

But, in retrospect, we think this wasn’t the best possible way to present our findings.

Consider the estimable Jonathan Hook, for instance, who arrived only in mid-2008 at the Ohio State Universityendowment. It’s not entirely fair to saddle him with the mediocre performance of OSU before he got there (he was their first CIO), even with the explanatory note we included.

Mr. Hook’s performance at Baylor University in 2001-2008 was outstanding and, undoubtedly, that performance helped him get his job at OSU. In 2005, we note, Endowment and Foundation Money Management named him endowment officer of the year.

By our calculations, OSU’s average annual return in the three pre-Hook years 2006-2008 was about 5.1%. In that same period the Baylor endowment under Mr. Hook earned about 12.3%. Big difference.

His average return over 2006-2010 (splicing together his performance at both schools) was about 4.7%. And his weighted-average annual compensation was about $515,000.

On this basis, his pay-for-performance number (bps/$100K) is now 470/5.15, or about 92. And this would move him up from near the bottom in our ranking to near the top: from 49th to about 5th.

But this kind of ad-hoc treatment is obviously undesirable.

We could finesse this by simply omitting from the rankings any CIOs who didn’t work for a full five years at their current post, and we probably will do that in future.

One ratio to rule them all:

One important difference between portfolios is how much risk they want to incur. By modifying our performance-for-pay statistic we were able to look at the ratio of risk-adjusted returns to compensation. This went some way toward taking into account different institutional objectives and leveling the playing field.

Some readers seem to have missed this table because we put it in an appendix. We thought the “absolute return” version was easier to assimilate, so we put it up at the beginning. Besides, the rankings didn’t change very dramatically between the two versions.

Jim Dunn, who took over as CIO at Wake Forest University last year, endorses this approach to measuring CIO performance. He’s been quoted as saying that he’s the only CIO he knows of whose bonus formula is tied the risk-adjusted returns he achieves as measured by the Sharpe ratio.

Undaunted:

Summing up, we think the 1.0 version of our performance-for-pay analysis provided useful information we haven’t seen elsewhere. Version 2.0 will be bigger and better.

In 1992 Australian Prime Minister Paul Keating pushed through a system of national “superannuation” funds which are the main pillar of the Australian retirement system.

The supers are essentially defined-contribution vehicles. Employers make a compulsory 9% contribution and employees can add more on a voluntary basis. All the contributions go into investments specified by the employee. Most of the supers are non-profits, but a few are “retail” for-profit entities.

Thanks to the supers, Australians now have more money in managed funds, per person, than the citizens of any other developed country.

The most amazing aspect of the supers, from a Yankee point of view, is that they treat their citizens like grownups. Workers can choose among hundreds of competing funds and specify what kind of asset allocation they prefer. And, they can simply take their money along when they switch jobs. A lot of those funds go to work in the Australian economy, which has done very well over the past 20 years.

Super fund investors took a thumping in 2008/2009, as all investors did; but, by the end of 2011, the typical investor had broken even on a five-year basis. Over ten years, the typical superfund investment has generated an average annual return of about 4.5%, compared to just 2.7% for the S&P 500.

Hazel McNeilage, our guest today, helped invest money for some of the largest supers and she thinks that, in time, all advanced countries will follow their model.

Maybe, but it will be politically tricky. Mr. Keating, the father of the supers, was a trade unionist and Labor Party stalwart – a left-winger by American standards. But in 2000, when presidential candidate George W. Bushpointed to the Australian supers as a model for reforming the U.S. Social Security system, he was roundly denounced as the proponent of a crazy, right-wing scheme.

Still, Ms. McNeilage may be right in the end. We could do worse; and have.

Hazel McNeilage is the former head of funds management at the $60.2 billion Queensland Investment Corporation, a nonprofit owned by the government of Queensland. It’s the 4^th-largest institutional fund manager in Australia, and its clients include 12 of Australia’s largest super funds.

She stopped by my office in San Francisco recently on her way from Brisbane to New York. We talked about how Australian CIOs look at the world and how the competitive pension management environment in Australia differs from the American model.

Skorina:

Hazel, you’re a truly global investment manager. From England, to South Africa; then Australia, Singapore, New York; and back to Brisbane, Australia as deputy CEO and head of funds management at QIC. What have you learned from all your postings?

McNeilage:

I think some American politician said that all politics is local. Investing is global, but that doesn’t mean there isn’t always a strong home bias wherever you are. You invest based on what you know and if you’re in, say, Singapore you have a clearer view of Asia than you get from New York, and you use that edge.

In our case, even though Australia only has 23 million people, QIC has over half their AUM invested in-country. There are some practical reasons for that, which I’ll get into in a minute. But with public pensions, especially, there is always strong political pressure to invest at home.

Skorina:

So how is the Australian pension system different from pensions in the States?

McNeilage:

I think we may actually be the model for where pensions are headed in Canada and, further down the road, the U.S. We have a good system, and I’m not saying that out of bias.

Almost all Australian super fund assets are managed by a handful of mostly private and crown-sanctioned money management firms like QIC. In fact, only a few banks and stray companies run their own pension plans. BHP Billiton, for instance, the giant mining firm which is Australia’s biggest company, does not have their own pension plan. All employees choose one of the “Supers” and that’s where the contributions go. Aussies don’t have to worry about losing their pension benefits if they change employers, get laid off, or just get lost in the bush for a few years. Pensions are independent entities. The government mandates a 9% employer contribution for all workers and that money stays in the hands of management companies like QIC until retirement.

Skorina:

So, your pensions are totally portable and they’re like a blend of U.S. Social Security, a defined contribution pension and a 401K, all in one. Government regulated, but privately managed.

McNeilage:

That’s pretty close, Charles. Australia also has a separate means-tested social security system as a safety net for retirees, but the supers are the main source of retirement income for most people. The supers are closely regulated, but also intensely competitive. In the internet age, there’s a vast amount of information available to the public on how each plan is doing. Performance is closely followed and the employees can change plans if they’re dissatisfied.

The downside is a lot of herd behavior; the plans tend to follow each other closely. At QIC, in the typical “balanced” allocation which most people opt for, we have about 30% in Australian equities, 30% in foreign equities, 10% in Australian real estate, 25% in cash and fixed income, and 5% in infrastructure. And our competitors are very similar not much different. Of course, the Australian stock market has done well the last few years, so who’s going to be the first one to pull out? Nobody wants to be the first.

But there’s another factor here. If we are all dancing the same dance, with similar allocations, how do you get a better return than you’re competitor? Only one way: by cutting costs and becoming the low cost-provider. We call it the MER – Management Expense Ratio – and everybody looks at it. The funds even use it in their advertising.

Skorina:

So does that mean salaries are really low at the Australian plans? Like the public plans in the States?

McNeilage:

Believe it or not, we can actually pay our management people very competitively. QIC has over 450 people in the investment management company (we don’t administer the benefits), and the salaries are probably equal to what the big US endowments and foundations pay, even though we are a quasi-public entity.

Skorina:

If everyone is well paid, how do you cut costs?

McNeilage

The cost of an investment actually affects investment behavior. Take private equity, for example. All the big Australian funds are cutting their investments in the PE mega-managers because their fees are so high when you look at all the ways they pull out cash.   It’s not just two and twenty, it’s special dividends, captive consulting fees, private jets. It all adds up. In the case of QIC, because of our size, for us to move the needle on an investment we would have to make a very big allocation to private equity. But that means our MER will get hit. So we and the others are pulling back from that sector.

Skorina:

That’s really interesting, Hazel. Everyone in the U.S. gripes about PE fees, but most funds still seem to be piling into them, expecting higher returns. How’s the Australian economy doing? Is it still a big resource play and coupled to growth in China?

McNeilage:

It’s tricky now, Charles. Australia, unfortunately, is a two- speed economy these days. Mining is running flat out, no worries. But manufacturing and tourism have taken big hits. Our dollar is so strong that we are not competitive on manufacturing exports, and we’re not a particularly good vacation value. Australia is expensive. The Aussie dollar has doubled in ten years.

Skorina:

How about your career, Hazel? What’s next for you?

McNeilage:

I’m still in the game, Charles! I’ve got a US green card, UK and Australian citizenship, my children are grown, and my husband and I own an apartment in Manhattan. We love New York and I think it’s time we returned. For my profession, it’s the center of the universe; and I have experience I think would be very valuable to a firm with international focus.

I told QIC that with my kids headed to Canada and the UK, my husband and I are moving on, I’m looking forward to the next chapter.

Skorina:

Thanks so much for stopping by, Hazel, I enjoyed it. Keep me posted on what you’re up to.

McNeilage:

My pleasure, Charles. Maybe next time we’ll get together in New York.

[Ms. McNeilage's planned departure from QIC was announced in September, 2011. It closely followed an announcement that QIC chief executive Dr. Douglas McTaggart will leave on June 30, 2012 after 14 years in the job.

Before his appointment to QIC, Dr. McTaggart was an official of the Queensland Treasury Department. He is one of many recent departures from official positions in the expectation that the Queensland government will change hands at the next election. It has been suggested that a government post might be available to him under a new Liberal National Party government.

It was announced last week that QIC had hired Damien Frawley as its new CEO. Mr. Frawley was previously CEO of BlackRock Australia in Melbourne.]

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.”

—————————————

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.

—————————————

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.

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.

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