The $95 billion Ohio State Teachers Retirement System (STRS) is facing a special state audit over a report that accuses the pension fund of secretly collaborating with Wall Street firms, lacking transparency, and wasting billions of dollars.
In June, Benchmark Financial Services released preliminary findings of a forensic investigation of Ohio STRS titled “The High Cost of Secrecy.” The report ripped into the retirement system, saying it “has long abandoned transparency, choosing instead to collaborate with Wall Street firms to eviscerate Ohio public records laws and avoid accountability.”
The Ohio Auditor of State’s Office recently sent a letter to Ohio STRS Executive Director William Neville saying it has received “numerous complaints” regarding the report and that it had conducted a preliminary examination into the matter.
Heather Gillers : So alternative investments are typically not assets that can be traded on the public market like stocks and bonds, where you know the price, you can buy them and sell them any time. They’re fairly liquid, very liquid. Alternative assets. On the other hand, are private market assets, they’re typically illiquid. So examples would be like private equity where you’re investing in private companies, not in publicly traded stocks, or infrastructure like roads and bridges, or real estate, apartment buildings, hedge funds was a long time popular alternative asset that’s lost some of its favor with public pensions. Private credit is one that’s gaining steam. That’s private loans to companies. Not bonds that are traded on the public markets, but private loans.
J.R. Whalen : So from an investment perspective, how are these alternatives different from traditional things like stocks and bonds?
Heather Gillers : So stocks and bonds are traded on public markets. You can pretty much always find a buyer. You can always find out how much it costs. And most importantly, like you can pretty much cash out any time. Whereas an alternative investment, you’re probably planning to hold it for 5 or 10 years at the minimum. And if you do have to sell it in an emergency, you could end up getting a lot less than you hoped.
The lawsuit notes the difficult position the retirement system was in, saying that “there was no prudent investment strategy that would allow KRS to invest its way to significantly improved funded status,” and that “the trustees were trapped in a demographic/financial vise.” However, while acknowledging there was no prudent investment strategy for KRS to get out of the hole it was in, the plaintiffs are simultaneously critical of Carlson and the other defendants for taking what they consider to be “longshot imprudent risks.”
The lawsuit also criticizes the hedge funds of funds for not providing high enough returns for the entire KRS portfolio to meet or exceed its 7.75% assumed rate of return. However, the same could be said for fixed income and many other assets in the KRS portfolio. Broad hedge fund portfolios are generally created to reduce risk, not beat equity markets.
“The Black Boxes did not provide the investment returns trustees needed for KRS to return to or exceed on the average its AARIR [assumed annual rate of investment return] of 7.75%,” says the lawsuit, which is targeting approximately 3% of KRS’ overall investments, while saying they should carry the entire portfolio to meet or outperform a rate of return the state acknowledged as “unrealistic and unachievable.”
The lawsuit also claims the investments “lost millions of dollars in 2015 to 2016,” which was more than two years after Carlson left, and which was a particularly bad time period for the entire hedge fund industry. The lawsuit criticized one of the investments, known as the Henry Clay Fund, for providing “exceptionally large fees for Blackstone”; however, the suit also states that “the amount of the fees could not be calculated and were not disclosed.”
Mr. Majeed is the investment chief for an $18 billion Ohio school pension that provides retirement benefits to more than 80,000 retired librarians, bus drivers, cafeteria workers and other former employees. The problem is that this fund pays out more in pension checks every year than its current workers and employers contribute. That gap helps explain why it is billions short of what it needs to cover its future retirement promises.
“The bucket is leaking,” he said.
The solution for Mr. Majeed — as well as other pension managers across the country — is to take on more investment risk. His fund and many other retirement systems are loading up on illiquid assets such as private equity, private loans to companies and real estate.
So-called “alternative” investments now comprise 24% of public pension fund portfolios, according to the most recent data from the Boston College Center for Retirement Research. That is up from 8% in 2001. During that time, the amount invested in more traditional stocks and bonds dropped to 71% from 89%. At Mr. Majeed’s fund, alternatives were 32% of his portfolio at the end of July, compared with 13% in fiscal 2001.
To compensate for the ongoing pressure on interest rates, CIOs participating in our survey have made substantive, structural shifts in their asset allocations. Why did they make this transition? We believe that CIOs are embracing complexity and the thoughtful use of illiquidity, as public market assets roll off and excess cash builds up. Improved asset-liability matching and more robust risk management have also helped, we believe. Reflective of these shifts, non-traditional investments, including Real Estate Credit and Structured Credit, collectively experienced almost a 1,200 basis point increase in market share. As a result, total
non-traditional investments now account for 31.8% of total portfolios surveyed, compared to 20.3% in 2017. As we detail below and in Exhibit 21, our work shows that 100% of the gain came at the expense of traditional public credit, which fell to 48.5% of portfolios surveyed, compared to 60.7% in 2017. Meanwhile, the allocation to Liquid Equities (predominantly by Property & Casualty and Reinsurers that typically favor Public Equities for liquidity) slipped to 5.5% from 9.1% over the same period. Cash as a percentage of assets is now at 4.9%, which is almost double the level it was the last time we did the survey. See below for full details on this increase but we think high cash balances are fueling thoughtful moves into longer duration assets. However, there is obviously more work to be done, as the supply of yielding, long-term assets remains limited.
The Chicago Policemen’s Annuity and Benefit Fund (PABF) – commonly referred to as the “Chicago Police Pension Fund” is one of the worst funded public pension plans in the U.S. today and in U.S. history. Its funding ratio as of today is only 23%.
It is also so damaged by a total lack of transparency that it puts the interest of Wall Street & Chicago Investment Managers over its own current and retired officers. PABF has hidden $10s of millions in investment fees, while denying payment for a disabled officer’s wheelchair.
Retired Chicago Police Officer Rosemarie Giambalvo initiated the call for a complete forensic audit of the Chicago Police Pension fund in February 2020 seeking full transparency and accountability. Rosemarie also founded the CPD Pension Board Accountability Group consisting of over 2600 retired, widows, and active officers who signed two petitions calling for the audit. Rosemarie was told during the February 2020 Pension Board meeting that, “whoever wants an audit must pay for it?” One trustee then stated, “it would cost $20,000”. Rosemarie notified the group members and within two weeks raised the full $20,000 from the group to pay for the audit costing the pension board nothing. Justin Kugler stated, “he didn’t care how much money they raised, we will not consent to a forensic audit!” After the elected trustees refused to address the concerns of their underfunded pensions (22% in 2020), the group agreed to hire myself Christopher Tobe, a Forensic Investigator to which I began the forensic audit report upon being hired by Rosemarie Giambalvo and the group.
The board and staff of the Chicago Policemen’s Annuity and Benefit Fund (PABF) have gone out of their way to conceal and block information for this report. They illegally denied most of our Freedom of Information Act (FOIA) requests only providing small amounts of information which should have been previously disclosed on the web page.
Regardless, we have come up with a report that can have an impact by providing more transparency and accountability for the operations of the fund.
It is reasonably well-known that the pension plan has been underfunded for years, and that the state, in setting a new funding plan, allowed a “funding ramp” in 2011 and then re-set that ramp in 2016, so that funding according to the “90% funded by 2055” target only began in 2020. However, Tobe alleges that “Chicago has consistently underfunded the plan more than the statutory amount, blatantly breaking the law, with no consequences.”
Regarding fees and management, Tobe alleges that the pension fund has “failed to monitor and fully disclose investment fees and expenses” and that “fees and expenses could be 10 times that which they disclose” because the fund’s disclosure “omits dozens of managers and their fees.” He also reports that the Fund claimed that “hundreds of contracts for the investment managers” are exempt from FOIA, and denied him access to the fund’s own analysis of fees. He concludes that “PABF may have over 100 ‘ghost managers’ in funds of funds,” that is, the fund is required to disclose its managers but it fails to do so, even though Tobe has identified them through other sources.
With respect to governance, the fund violates a fundamental aspect of prudent governance because its Chief Investment Officer is not a professional with qualification in the field, but simply a trustee and active-duty policeman, and, what’s more, one who has “22 allegations of misconduct as a police officer including one for bribery/official corruption.” Further, no staff members hold the credential of a CFA charter, another marker of professionalism. Another related governance issue is the use of offshore investments, e.g., in the Cayman Islands, which lack key governance and transparency protections of US-based funds.
Clearly, we need to do everything we can to cut the cost of our annual pension payments at both the state and local levels in order to continue to guarantee the retirement payments our retirees have earned and to reduce the unfunded liability that is such a burden to taxpayers.
That is why we have developed legislation to enable our state and local pension systems to add revenue-generating assets like water and sewage treatment systems, High Occupancy Toll (HOT) lanes, parking facilities and real estate to provide new, diversified sources of revenue for their investment portfolios.
The Chicago Policemen’s Annuity and Benefit Fund (PABF) —commonly referred to as the Chicago Police Pension Fund—is one of the worst funded public pension plans in the United States today, with a funding ratio of only 23 percent.
A group of retired and disabled officers, along with widows, has long questioned the trustees and management of the struggling pension. Dissatisfied with the responses they received, the group formed the CPD Pension Board Accountability Group.
Funds were raised to commission an independent forensic audit of the pension and an expert in pensions was retained recently to conduct the review. As Forbes readers will recall, in my recent book, Who Stole My Pension?, I encourage pension stakeholders to band together to fund independent forensic investigations by pension experts of their own choosing—to get a second opinion as to whether the pension fiduciaries and Wall Street “helpers” they have hired to manage investments are doing a good job.
Forensic investigations in Rhode Island, North Carolina, Kentucky and Ohio reveal that gambling 30 percent or more on high-cost, high-risk, secretive alternative investments has exposed pensions to massively greater risks and reduced net returns. The time is ripe for legislators, regulators, and law enforcement to act to stop the looting.
A recent New York Times NYT-3% article revealed that putting more than half of the $62 billion Pennsylvania state teachers’ retirement fund’s assets into risky alternative investments hadn’t worked out well for the pension and had spurred an investigation by the FBI. The FBI is investigating reporting fraud—returns allegedly falsified to avoid increased worker contributions to the pension.
Law enforcement investigations into public pension funds that lie about their returns are long, long overdue.
What you see in that graph is a data point for each of the plans I know their asset allocation for, with the median, 25th percentile, and 75th percentiles marked out so you can see the allocations increasing.
That pattern does not make me feel good.
Allocating more to alternatives doesn’t seem to get asset managers higher returns. But the group is generally sliding upwards in their allocations, and I’m very unhappy about this.
The search for high returns takes many pension funds far and wide, but the Pennsylvania teachers’ fund went farther than most. It invested in trailer park chains, pistachio farms, pay phone systems for prison inmates — and, in a particularly bizarre twist, loans to Kurds trying to carve out their own homeland in northern Iraq.
Now the F.B.I. is on the case, investigating investment practices at the Pennsylvania Public School Employees’ Retirement System, and new questions are emerging about how the fund’s staff and consultants calculated returns.
The error in calculating returns was a tiny one, just four one-hundredths of a percentage point. But it was enough — just barely — to push the fund’s performance over a critical threshold of 6.36 percent that, by law, determines whether certain teachers have to pay more into the fund. The close call raised questions about whether someone had manipulated the numbers and the error wasn’t really an error at all.
“If you can’t change the benefits, and you can’t change the contributions, the only lever left for these people to pull is investment policy — that’s it,” said Kurt Winkelmann, a senior fellow for pension policy design at the University of Minnesota’s Heller-Hurwicz Economics Institute. “And that exposes younger beneficiaries and taxpayers to a lot of risk.”