October 2006
What attracted you to the job at PRIM?
In 1994, I was appointed to run the city of Boston’s defined benefit plan. I was practicing law then, and didn’t know what a defined benefit plan was. But I just fell in love with investing assets in an attempt to beat a goal. It makes every day and every week and every quarter a new challenge.
As executive director, I oversee a staff of 21 that’s split evenly between investment staff and back-office operations such as accounting. I’m responsible for the day-to-day operation of the plan, of those 21 employees, who implement decisions made by our nine-member board of trustees.
Does the job include riding herd on outside asset management firms?
That’s the bulk of what we do on the investment side. Some state plans manage their own portfolios, especially the passive portfolios, but all our money is managed externally.
Before we hire a manager, we issue RFPs [requests for proposals], and managers interested in bidding for our business can submit proposals. Once a manager is hired, we have two annual due-diligence visits, one on-site at PRIM and one on-site at the manager’s. And we review performance quarterly. Because we’re long-term investors, we don’t get nervous because of a quarter or even a couple of quarters of underperformance. But you also have to watch for things like mergers and acquisitions of asset management companies. These are as important as investment performance because, when they happen, portfolio management personnel may leave, or they may have too much money now, so that they’re not as incented to perform the way they used to.
Has PRIM fired any outside money managers in the last three or four years?
Yes. To give you an example, in 2003 we were using one investment firm for two of our portfolios when the market-timing scandal broke, and the senior investment people on one of the two portfolios turned out to be involved in the market timing. So we terminated that portfolio.
Then, this past June, we fired another asset management firm. They’d been managing small-cap equities for PRIM for nearly ten years, and for the first few years, they exceeded their performance expectations. But more recently, there was a sustained period of underperformance relative to their benchmark. So we removed them from the portfolio.
What key challenges face state and other public retirement systems?
Many public systems face a mandate to reduce unfunded liability. Even at $43 billion in assets, the Massachusetts system is only, as of the first of this year, about 82 percent funded. So PRIM’s biggest challenge is to get fully funded, by beating our benchmark. We’re on a schedule that takes us out to 2023, when by law the state pension system must be fully funded. To get there, we assume an actuarial rate of return of 8.25 percent, and that’s not so easy to achieve, especially in current capital market environments.
Another, increasingly common approach to underfunding in both public and private sector pensions is to move to defined contribution plans.
I think if your goal is providing retirement security, then moving to defined contribution plans is a bad decision. Because moving to defined contribution plans transfers the risk of retirement security onto the individual and away from the employer. It's being done without any widespread education efforts. A lot of people have only been in a defined benefit plan, and they’re not used to making investment decisions. I think at the end of the day, a number of employees are going to be worse off financially than those covered by defined benefit plans. The move to defined contribution plans will be great for mutual fund companies because money will pour into 401( k )s. I just worry about what’s going to happen to it when it lands there.
Could the Massachusetts public pension systems go down that road?
Yes. Kerry Healey, the lieutenant governor, who’s running for governor, has called for freezing the defined benefit plan and converting new employees to a defined contribution plan. So if she’s elected governor, I believe you would see a push for that.
She’d have to talk the legislature into it, though.
Right, and in this state, I don’t think it would happen. We’ve got strong labor unions that do a good job of representing their members, and again I agree with them that this proposal is not in their members’ interest.
As a state agency, what kind of political oversight does PRIM face?
The nine trustees of PRIM—including the state treasurer and his or her designee, three
designees of the governor, and four trustees elected by the pension systems--are governed by the fiduciary prudent-person standard, but there’s no regulatory body per se. But this is Massachusetts, and it’s a very political environment, so we conduct all our business in public meetings, and the Globe and the Herald routinely attend. So when the fund does well, you might read an article about that, and when it doesn’t do well, you’ll read about that. When we invested in hedge funds, as I said, we were criticized for taking on too much risk. And when the market-timing scandal was happening at one of our outside contractors, it was sort of, “You have to fire them. It shouldn’t even be a question.”
But as political as Massachusetts can get, overall the fund has been left alone, or at least alone enough to generate good long-term results. I don’t know how much better you can get than 11 percent, or just under 11 percent, over the last 20 years.
Are there any advantages to operating with that kind of scrutiny?
Yes, vis-à-vis our relationships with vendors. We can negotiate hard on fees because we can say, “We pay what we pay, and we can’t pay twice that because people would complain.”
Approximately two-thirds of the Commonwealth’s public pension systems manage part or all of their own money, but there have lately been proposals to force them to invest all their assets with PRIM. What advantages and disadvantages do you see in that, both for PRIM and for the pension systems?
Let me preface my answer by saying that under the current statute local systems can invest in PRIM voluntarily, and 70 of the 106 systems do. Some do it only in one asset class, like real estate or hedge funds or private equity; some give us all their money.
As for making it compulsory, several groups have done reports about how much money is being lost under the current situation, and I don’t buy that in total. A number of local systems have invested on their own, and their 20-year track records are very close to PRIM’s. On the other hand, if you look at the track record of a number of systems that I’m not going to name, they would have done better with their assets under PRIM’s supervision. Some have given up as much as 300 basis points in investment earnings over 20 years, when you compare their investment results to PRIM’s. Asset management is a business of size and scale, and at $43 billion we can get fees that no small investor can. And in asset classes like private equity and hedge funds, which are highly specialized, we can also get access to some of the best managers, ones who you can’t access at smaller asset sizes. So clearly there are reasons for a lot of these local systems to look at PRIM.
The advantages to PRIM of having more systems invest with us are essentially none. It would actually add a little more work for PRIM staff because we’d now have a hundred-plus clients instead of 70, so there would be more reporting and client service. But in the grand scheme, we do have the capacity to absorb the remaining systems’ assets without any hiccup in our operations.
I’ve read that only six local pension systems have beaten PRIM’s ten-year performance numbers, while many, as you just said, were outperformed by 100, 200, or 300 basis points. Why do funds like that still want to operate on their own?
They have to look at their benchmark, not at PRIM’s performance. That means they need to get about 8 percent or 8.25 percent—some have dropped it down to around 7.75. So if there’s a fund out there that’s gotten 9 percent over the last 20 years, they can appropriately claim that they achieved their mission. And then, of course, we’re looking at past performance when we compare PRIM’s results to the local systems’. So they can say, “PRIM beat us the last ten years, but who knows what the next ten years will be?”
But candidly, any of these systems that wants to do private equity and doesn’t use PRIM, that’s hard to justify because we’re in the top general partners and have been for a long time. Those that want to do hedge funds and don’t use PRIM, at $100 million or $130 million in total assets, that’s also hard to justify.
Where do you go for insight and dialogue on trends and strategy in asset management, and how might a research center like the Center for Asset Management contribute to your success?
Not to be cute, but we go wherever there’s useful information. So the center can be a clearinghouse and a resource. We might come to them and say, “Hey, we’re thinking about going in this direction. Has anybody over there written or thought about this kind of stuff?” With $43 billion to invest, we can go to any one of the money managers and say, “Create a product. We’re looking for returns of ‘X’ with not much risk.” But I don’t like going to the sell side all the time because they’re motivated by self-interest. To do it with an academic or purely research focus makes us more comfortable because we know there’s no agenda.