Pensions mull new pay models

Jim Treanor spent 11 years building a $10 billion portfolio for the Florida State Board of Administration, as the chief of its private equity programme. Then he left.

Florida, like many public pensions, had become a victim of its staff’s success. Treanor’s talents as an investment professional opened up more lucrative opportunities for him in the private sector – one of which he ultimately chose to take up by leaving the $119 billion retirement system to join Jeffrey Slocum & Associates last September.

“Highly-qualified investment professionals are sought-after individuals. And ours is an industry where talent is worth something,” SBA chief executive and chief investment officer Ash Williams tells Private Equity International. “The rest is sort of self-explanatory.”

Treanor did not respond to a request for comment.

The historical trend of investment professionals leaving the public sector for private sector positions is driven in large part by money. A recent PEI survey found that top-level investment professionals bank an average base salary of $793,000 in the private sector. By comparison, California Public Employees’ Retirement System chief investment officer Joseph Dear took home a total of $522,594 last year (base pay $438,165), according to a Sacramento Bee database.

That’s a big pay gap – and it’s enough to persuade many public pension officials to switch sides. Over the last year, the US Securities and Exchange Commission has lost two of its private fund investigators to the private sector, while Christine Pastore resigned as the co-head of alternatives from the New Jersey Division of Investment. The Massachusetts Pension Reserves Investment Management Board and Pennsylvania State Employees’ Retirement System have also had to cope with private equity professionals jumping ship to the private sector within the past few years.

As a result, Florida has now launched a review of its investment staff’s compensation structure, which may include performance-based incentive pay in an effort to retain talent, according to Williams. And it’s not alone: the Orange County Employees Retirement System has also just begun to explore the possibility of offering its investment staff incentive pay, to prevent the so-called ‘brain drain’.

“If we’re going to invest in the best funds possible, we have to compete to get the best talent possible on our side,” OCERS chief executive officer Steve Delaney tells PEI. He believes that offering more competitive pay is one of the most effective ways to do that. And it also serves another important purpose: staff retention creates institutional memory, which allows for greater consistency in the implementation of long-term private equity investment strategy.

However, putting such a compensation structure in place is easier said than done.

Hard to argue

“Having more, let’s say, performance-oriented compensation would be very helpful … But I think it’s tough to address given some of the fiscal challenges where these funds operate and their governance models,” says former Ontario Teachers’ Pension Plan private equity head Erol Uzumeri, who left the Canadian pension plan in 2010 to launch Searchlight Capital Partners.

Uzumeri’s situation was actually slightly different from that faced by many of his peers – because unlike most US pension systems, Ontario Teachers’ investment team operates through an independent corporation that allows for greater compensation.

But instituting that sort of model would be a tall order for most pension systems, says GloCap CEO Adam Zoia. “It’s difficult to pull off. It creates a lot of ire with the unions”. Furthermore, he adds: “In the two cases where I’m familiar with that, the pay is still less than would it be at a privately held fund”.

The implementation of smaller scale internal performance-based pay models can be difficult as well. Many public pensions are hampered by weak markets and budget shortfalls. Offering incentives, which some may view as a pay raise, could face political challenges in states where pensions have struggled in the years following the downturn.

For instance, in November, MassPRIM drew fire for setting aside roughly $250,000 for staff bonuses in a year when few public employees had earned raises, according to reports. Massachusetts state treasurer Steve Grossman did not respond to a request for comment.

The political and economic environment over the last two years is one reason why Delaney held off on his request for incentive-based pay until now. In 2011, 90 percent of state retirement systems were underfunded, with assets outweighed by liabilities, according to Wilshire Consulting study that analysed actuarial data from 102 retirement systems. While that is an improvement on the 98 percent who reported being underfunded in 2010, many systems still have a long way to go.

Michael Karp, CEO of executive search company Options Group, has urged his clients not to rely on a stronger economy boosting public pensions’ compensation levels.

“Everyone’s been talking about the economy getting better for the last four or five years, and it hasn’t gotten better,” he said. “There’s a lot of emphasis on cutting costs as well; a lot of pensions are outsourcing their costs.”

Worth the risks?

Orange County does not seem to be following that trend, however. After managing the plan through the downturn, Delaney said he felt comfortable approaching the board on the issue. The move was also prompted by the staff’s recent exploration of doing direct hedge fund investments (it plans to explore similar direct strategies for private equity in the future).

“We’re starting into this consideration of direct hedge fund investment,” he said. “Does this mean we should start looking [at incentive pay] … since our staff is going to be doing this task they haven’t done before?”

Any offered incentives would be moderately sized, tied to benchmarks and only apply to investment staff, according to board presentation documents made available to PEI.

Incorporating incentives into the compensation of investment staff could also be used as a set of “golden handcuffs”, Delaney added, in which incentive pay for that year is relinquished if a professional decides to leave.

The board has expressed some concerns, however – not least whether instituting pay-for-performance would create a situation in which investment professionals take undue risk. If OCERS were to adopt incentive pay, it would need to incorporate improved risk control metrics, according to Delaney’s presentation documents.

Those considerations are particularly important in the wake of the global financial crisis, public pension expert and University of Toronto professor Keith Ambachtsheer said in a May/June newsletter last year. Only a handful of the pension funds surveyed had begun to implement protocol to ensure that incentive compensation does not lead to excessive risk-taking.

However, even with those risks, Ambachtsheer said that he was surprised more pensions haven’t established incentive pay for their staffs.

“Investment professionals in pension funds around the world are well-compensated relative to general wage levels, but with the noted exceptions, less so when measured against comp levels for similar positions in the commercial financial services industry. In some cases, this is due to externally-imposed constraints on fund compensation,” he wrote. “The wisdom of placing such constraints should be carefully examined.”

It’s clear that for the likes of SBA and OCERS, these constraints no longer seem particularly wise. n