Stemming the pension brain drain

US public pensions rely now more than ever on their private equity portfolios to help fulfil obligations to beneficiaries like teachers, police officers and other civil servants.

So it may seem counter-intuitive that the salaries private equity investment staff at pensions take home pale in comparison to what they could earn in the private sector. Given most US public pensions are run within government entities, getting salary increases approved is challenging as budget-strapped states worry about making ends meet as well as headline risk – it doesn’t look good when public workers, even those in charge of fund investments, make more than the governor.

Over the past year, several top-ranking private equity leaders at public systems have stepped down, most heading into the private sector where they can boost their compensation levels beyond what they make at state funds. This is not a new trend – private equity chiefs and CIOs at public systems have been known to move around, but what is significant is the sheer volume of people leaving their posts recently, sources have told Private Equity International.

The most recent resignation came from highly regarded LP Christine Pastore, who headed New Jersey’s $70 billion state pension system’s alternative investment programme. Pastore was integral in launching the system’s private equity portfolio in 2005, building relationships with desirable general partners and expanding the programme to incorporate secondaries and customised accounts.

New Jersey now has the task of trying to replace the person who built the portfolio and will want to minimise disruption to the programme Pastore kick-started. Bringing in a top private equity talent could prove challenging as no public pension can offer a pay package anywhere near the private sector. The system’s chief executive officer, Tim Walsh, who was Pastore’s boss, was making $185,000 as of last year. Compare that to Jane Mendillo, CIO at Harvard Management Company, whose total compensation was $4.7 million in 2010. A Private Equity International survey conducted earlier this year revealed that a typical top-level investment professional at a firm takes home a $793,000 base salary, before bonus and carried interest.

So how can a US public pension system compete? Taking a serious look at how the pensions are structured seems the most obvious solution. Some systems are experimenting with models more akin to endowments or Canadian pensions by setting up investment management companies. With this model, the investment division is independent from other arms of state government and professionals can expect salaries more in line with those in the private sector. The Virginia Retirement System uses such a model, and last year was able to recruit long-time Oregon state pension system CIO Ron Schmitz reportedly offering a pay package well above what he made in Oregon. New York City and Washington State are also considering making changes to move more in this direction.

It remains to be seen if states with highly politicised legislatures – like New Jersey's – will be amenable to such changes. But New Jersey’s recent loss of Pastore should serve as an urgent reminder to pensions and their boards that they must fight for structures enabling them to better attract and retain top investment talent.

These highly skilled individuals who manage billions of dollars and help secure the retirement future of thousands of state employees deserve to be compensated appropriately. If the pensions don’t rise to the challenge, there are plenty of private equity firms that will.