Texas Legislature Passes, Governor Signs Pension Transparency and Education Law

Back in December we informed our readers about Texas Comptroller Susan Combs wanting to introduce legislation to make pensions more transparent to the general public. Well, her effort has now become law after Governor Rick Perry signed HB 13 / SB 13 last Friday.

Whenever a major piece of legislation makes it through the process it’s always good to look back at why and how the process worked. Positive experiences deserve close attentions. Here’s our take on what happened.

First, TEXPERS appreciated the opportunity to participate in the bill’s formation from the outset, which was in early December 2012 when Ms. Combs held a press conference to introduce her desire to make Texas government, in general, more transparent. We obviously are in favor of transparency, and there was nothing of immense concern to us in Ms. Combs’ effort. However, we did want the public to know that there should be no inference that Ms. Combs’ was reacting to a total lack of transparency. Local and state pensions already provide the public with plenty of transparency into their operations, their investment returns, their benefits paid at every stage of their processes. We provided several newspapers with an op-ed that provided our view on all the transparency measures already in place, and you can read the op-ed in full at the Austin American Statesman, the San Antonio Express News and the San Antonio Business Journal. Ms. Combs wanted more pensions to use websites to engage in more discussions with their taxpaying constituents.

Second, our members are similarly concerned about the public’s perception of their pension operations. They want legislators and their local elected officials to feel comfortable with how they run their system. In December, we informed our 75+ members about Ms. Combs pending legislation and received very little feedback of concerns. In February, our members took a closer look at the actual legislation when Ms. Combs held a press conference to introduce her bill, named Senate Bill 13 and House Bill 13, through pension committee leaders Senator Robert Duncan and Representative Bill Callegari. We’d had time to see what was coming down and when it finally made its way to the legislature no one was surprised or taken aback by the bills’ contents.

Third, because of the long-lead times, we were able to discuss the legislation with our members with great focus in March and April. We provided the legislators with our input and tweaks along the way, both on behalf of our members and TEXPERS itself. That was because the bills were not solely about transparency. HB 13 / SB 13 also included some directives to the Pension Review Board requiring them to establish some training and education requirements of pension trustees. Of course, TEXPERS has long been the resource which pension trustees use to gain their education. Our Certified Trustee Training program has provided untold numbers of Trustees and pension administrators with education and training over the last 25 years. We’re glad Texas legislators have seen what we’ve known for a long time, that operating a pension is a very complex undertaking that requires tremendous care and concern. Our members have already been endeavoring to keep themselves up to date on the best possible opportunities for investments, and the best practices for managing and administering benefits.

In sum, by the time the bill was voted into law in May we, as a representative of Texas’s local pensions, had been included from the outset and participated in refinements along the way. It was a very positive experience for everyone involved. The process stood in stark contrast to previous years when sweeping statewide pension changes were considered. The success of HB 13 / SB 13 should be viewed as a model for introducing and shepherding any future legislation regarding pensions. – Max Patterson

Who Really Wants 401(k)s for Public Employees?

On May 1, future public employees of Florida dodged a bullet, and future residents of the state were given some guarantee of receiving the productive labor of motivated employees. Here’s what happened.

Florida senators voted 22-18 to pull a compromise amendment that would have shut future employees out of the state’s defined benefit plan and enrolled them in a 401(k). Eight Republicans joined all the Democrats to pull the bill from the floor.

As we’ve noted here many times before, public sector employees work for the benefits, not the salary, which are usually very low when compared to private sector employees. That is a significant budget consideration for state and local governments. They would not be able to afford comparable salaries that would retain their trained, experienced employees. Here’s what one Republican Senator said:

"One of the reasons they work for government is not for the salary," said Sen. Jack Latvala, R-Clearwater. "They haven't had raises in six or seven years. It's for the pension and if we want to continue to have the quality of employees that we have, we need to continue to offer that pension."

In essence, the Florida Senate took a very conservative position, preserving the status quo and failing to thrust future workers into the great unknown of 401(k)s.

So why are we paying attention to what happens in Florida?

Well, here in Texas there are many policy groups who are advocating a similar radical policy shift, from defined benefit to defined contribution plans. Thankfully our elected leaders aren’t listening to their mutual fund industry-backed proposals.

We noted in a previous blog how our Texas Comptroller Susan Combs told the media that there aren’t really any big problems at state and local pensions, and how decisions about the types of pensions a city uses are best left to local levels. Here’s what she said:

“Plan design is so individual. You may be able to have a great defined benefit plan depending on what’s going on. We’re agnostic on that [assertion that defined contribution plans should be employed instead]. We simply say ‘Know what you’ve got.’”

It’s evident to us that – because there was no bill advocating the dismantlement of defined benefit plans in this legislative session – most Texas lawmakers are taking the conservative approach advocated by Ms. Combs. Leaving things well enough alone is a good policy prescription. Republican and Democrat legislators see the wisdom of that in Florida. We’re glad they see that in Texas as well. – Max Patterson

Don’t Believe Everything Wall Street or Your Professor Tells You

In a previous blog entry, we noted how the Wall Street Journal – the newspaper that is written for stock and bond financiers and investors in New York – recently ran an alarmist but factually empty story that positioned the Teacher Retirement System of Texas as taking inordinate risks with its private equity portfolio. 

We noted how the story’s sky-is-falling “Pensions Bet Big with Private Equity” headline, and some wording in the third paragraph, might lead a reader to believe that “private equity and other non-traditional investments” are aggressive, risky investments when compared to those on Wall Street. In reading the story, it was not hard to infer that there is less risk from traditional stocks and bonds offered by the downtown New York financial companies, you know, the ones that advertise in the Wall Street Journal.

Our worry about the story was its implication that off-Wall Street investments, sometimes referred to as Main Street investments, are inherently more risky and don’t belong in public pension portfolios.

But when we added just a tad of critical thinking, we noticed that the story offered no comparisons of risk factors, or any proof of long-term return superiority of one style of investing. The story only notes how private equity investments play a big part of the TRS portfolio, saying “It now boasts some of the splashiest bets in the industry, having committed about $30 billion to private equity, real estate and other so-called alternatives since early 2008.” (Note the value-laden term “splashiest bets.”)

Even the following paragraph in that WSJ articled noted how the strategy is “averaging returns of 4.8% and 15.6% over the past five-year and three-year periods, respectively.” Not bad, in our view. The story did not include supporting evidence as to how those investments are risky or detrimental to TRS performance. Nor was contrasting evidence presented as to how other pensions’ private equity ‘splashy bets’ played out. Nor was evidence presented as to how “bets” using “traditional” Wall Street investments might have fared over the same time period, or which risk metrics were at play.

Our concerns that this article might negatively influence some people were well-founded, as it turns out.

Professor Elena Farah, senior fellow for public financial sustainability at the University of Houston, began her  recent blog by referencing that WSJ article and posited that the risks taken using private equity are “a perfect example of how misaligned incentives endanger public money. This can only hurt public employees and taxpayers in the long run.” She positioned public pensions as using “risky” private equity to achieve their overly aggressive investment targets.

Professor Farah’s blog article went on to offer one sky-is-falling scenario after the other, all of which supported her premise that private equity offerings are more risky than other types of investments and shouldn’t be used by public pensions.

This just simply isn’t true and her viewpoint is dangerous to taxpayers in many ways.

If anything, private equity components of pension portfolios offer one more element of diversification that help reduce the overall risks of an investment strategy. We’ve previously mentioned how, at one time, the City of Houston’s Treasurer’s strategy for pension investments was limited to U.S. Treasury instruments, which might seem risk-free, except for all the opportunity losses the city’s taxpayers were forced to pay for with higher contributions.

To offer an alternative view of alternative investments, we asked Marcelia Freeman, a director at Invesco Private Capital, to offer their justifications for the use of private equity in pension portfolios. Here’s what she said:

Throughout the Great Recession, we saw that these outsized returns could not be broadly found in public markets, and thus investors were forced to look toward alternative investments like private equity, hedge funds, bank loans, etc. These type of investments not only provide alpha beyond S&P 500 and T-Bill returns, they also provide other benefits like diversification, lower correlation among portfolio investments, etc.

Another major benefit for private equity includes investments in small business around the country, who otherwise were capital starved during the recession. The increase in pension fund investing in the asset class benefits not only pension fund members and beneficiaries, but also communities and economies in which we all must thrive, both in the short and long term. The cost of not investing in ourselves as a nation far outweighs the well-aligned manager fees paid to private capital firms.

“Lack of transparency” in alternative investments and even public securities often indicate inefficiency of markets. Profits are often gathered by skillful managers within inefficient markets, making manager selection paramount in order to produce significant alpha. With the use of consultants, investment committees, and other oversight mechanisms within public pension fund investing, high performing, top quartile managers can be hired, and can thus produce outsized returns for pension fund members and their beneficiaries.

We have more to say about other elements of Ms. Farah’s blog, but that will have to wait for future blog entries.

For now, we hope our readers understand that Texas pension systems seek to balance the risks they take. Wall Street investments are no less risky than Main Street investments, despite what the Wall Street Journal might implicate. And in many cases Main Street investments might be far more less risky, especially if they are more directly under the watch and control of a pension Board. Indeed, the failure to consider ‘alternative investments’ – in Wall Street speak – could actually be a violation of Trustees’ duty as fiduciary.

This subtle shift in orientation that seeks to deem Wall Street investments as “traditional” and alternative investments as “non-traditional” is dangerous to public perceptions about the steady work that pension Boards perform to find the best overall mix of investments for their members and taxpayers.  And this skewing of perception simply isn’t warranted based on performance.

In our view, one of the true shortcomings of the “move all public employees to 401(k) plans” arguments is that they would be limited to stock and bond mutual funds. As an asset class, those have not performed as well as commodities in recent periods, and thus their underperformance risk an entire generation’s opportunity to participate in wealth accumulation for retirement.

We continue to urge readers to view media many news reports and blogs with measured skepticism. Public pension investing is far more complicated, and its practitioners far more sophisticated, than some would have you believe. – Max Patterson

Conflicting Portrayals of Risk for Pension Portfolios

We like most are steady consumers of media, but it’s important to keep perspective whenever you read anything. And we mean ANYTHING!!

Consider the alarmist headline on the front page of the Wall Street Journal, “Pensions Bet Big with Private Equity” followed by the tone-setting sentences in the third paragraph:

It’s a sign of the times. Numerous pension funds are still struggling to make up investment losses from the financial crisis. Rather than reduce risks in the wake of those declines, many are getting aggressive. They are loading up on private equity and other non-traditional investments that promise high, steady returns in the face of low interest rates and a volatile stock market.   

Hmm… There’s a lot to argue with in that paragraph:

• Only people in New York, and on Wall Street might consider Wall Street investments to be “traditional” investments, whereas most people out in greater America still understand the value of investing directly, with up and coming companies, or their local farmer, or prime real estate, or popular restaurateurs, that fulfill the needs of people in regions, sectors, etc.
• Risk is an acquired taste. Not everyone enjoys the stockmarket roller coaster rides that Wall Street has provided the last 12 years. There are far more conservative investment opportunities that provide steady income out beyond the Hudson river. Only those with a New York, Wall Street perspective might consider Wall Street to be a reducer of risk!
• And given the track record of Wall Street investments over the last 10 years, which many call the “lost decade,” going off the Street could hardly be labeled “getting aggressive.” Others might term it “getting real” or “adjusting to lackluster results available through Wall Street.”

The story goes on to tell how Teacher Retirement System of Texas has dedicated about $30 billion of its $114 billion under management to “private equity, real estate and other so-called alternatives.”  By the time you get through the article – and you find that the TRS system is doing fine with its funding ratio and that it’s private equity holdings are doing a good job of providing income for retired teachers – you kind of want to say, “So what? If it’s working, why is this on the front page of the Wall Street Journal?”

We’ve been seeing more of these sorts of stories that micromanage and Monday morning quarterback Texas pensions’ investments. The Dallas Morning News had a long story about the Dallas Police and Fire pension’s use of luxury real-estate in its portfolio. We’ve heard of investigations into other pension’s investments. Dallas Police and Fire is one of the strongest performing pensions in the state, so again, at the end of the day, we say “So what?”

To confuse the average media consumer yet again, contrast all that with a Reuters story titled “Local pension plans punished by safe investments: study.”

The report notes how local pensions had, before 2007, invested too conservatively and fallen behind large state-run pensions in their funding ratios. The Boston College study then found that, after 2007, locally administered plans outpaced state-run plans using international stocks and alternative investments. Smaller pensions that didn’t have diverse asset classes fared the worse.

To all the confusion, we say this: Let local pensions do their job. They will find a way to make the money they need to pay their public servants. Texas has a very robust system that allows local pensions to pick investments that make sense and gain good returns. We’ll be releasing a survey soon that shows just how well they do. Don’t get confused by reports in the media that seem to conflict and confuse. Texas’ local pensions are doing well. – Max Patterson