To innovate as a consultant, you need to do two things: find clients that are willing to innovate, and occasionally get some time to think about the big picture.

“To think innovatively, you need to take a breath and think about what issues are important and what isn’t,” says Allan Martin, one of NEPC’s go-to consultants, and a regular knowledge broker here at CIO. “That’s a time-consuming process and you need a little time to free yourself up to be able to do that.”

The 18-year NEPC veteran with an investment career spanning more than 40 years has lived and breathed pension investing, and having experienced several cycles, says those who innovate, such as the $10.4 billion San Bernardino County Employees’ Retirement System, are better prepared for a downturn by going against the current.

“It’s just hard to be a prophet in your own land,” Martin said. “You have to get outside the conventional and then have the foundation to separate the crazy idea from the new idea that nobody else has tried before that actually might add value.”

He’s advised the San Bernardino fund since 2003, a staff and board he feels “blessed” to serve. Donald Pierce, its chief investment officer, “understands why he’s there and what he’s trying to do and is willing to do things differently even if he sometimes gets criticism.” 

“There’s a lot of public funds that would rather fail conventionally than take the risk of innovation and look different than the other guy,” Martin said. “The market goes down 20% and you’re 70% in equities and you get killed. You say, ‘well, everybody else did too.’ Is that really what you should be saying?”

One of the realms where Martin’s innovation paid off was helping San Bernardino, the $13 billion New Mexico Teachers, and the $10 billion Arizona Public Safety Personnel Retirement System capitalize on an element of the global financial crisis by assessing the situation and choosing to hold or invest in bank loans while others were selling.

“That was an area that we went into in a big-time way, and when I say big time, I mean San Bernardino, New Mexico Teachers, Arizona Public Safety over the next two or three years developed asset allocation targets for ‘private or opportunistic debt’ up in the 20% range,” he said, adding that they recognized that credit was “one of the great opportunities of our time” to earn “extraordinary returns” for risk taken.

“Initially, if you had stopped the clock after six months, there was a significant mark-to-market loss from others selling. Our point was no, we didn’t lose our money. All these loans were still paying interest at a contractual rate, and would return to par at maturity,” said Martin. He mentioned that private debt (also known as opportunistic credit) was all the rage among asset owners at a recent conference.

In addition to helping funds avoid paying hefty fees, one of the public pension issues Martin is currently grappling with is advising clients which risks to take and to avoid while convincing the board that it’s not always necessary to beat “the guy down the street” when there are thousands of people relying on the fund’s money for providing their retirement benefits.

“We’re starting to look at things for a county fund, such as what percentage of the county budget is consumed by pension contributions or how stable is the contribution rate,” he said, adding that while generating returns is important, it’s always in a context. “And so, trying to rethink risk-adjusted returns, stability of cash flow, and keeping contribution rates stable and generally low are the things which really matter, a lot of which would generally be addressed by the actuary. But if that’s what we have to understand to be better advisors, then we ought to step up and do it.”

Assessing fees and advising against funds paying managers for lackluster performances is another situation Martin is dealing with in addition to how the size of public plans can attract unwanted political attention.

“… I often say the problem with public funds is [that] they’re public, and as those pools of assets get very large, politicians and other entities notice them and they start to think ‘Well, gee, can I somehow use those assets to further my political interests whether it’s environmental protection or the solving a city/state’s housing crisis,’” he said.

As for fees, Martin and his clients have been looking to develop metrics that would capture the value add from paying the fee and not just the amount. 

“If you took Business 101, accountants are supposed to identify expenses incurred for revenue generated in a particular period and yet all of your draw-down strategies (private equity, private debt, real estate), you pay a manger fee today, they draw down the money, and they invest it over time,” he said. “It may be 10 years before you realize the value of all of that. So if you’re reporting the fee I paid this year as a commitment fee, it takes 10 years to actually see the result.”

When it comes to advising for these situations, Martin will present pension funds with metrics, and share concepts with staff and boards that he respects to get their opinions. 

“Does that get us closer to being more useful to a board? At the end of the day, if the board doesn’t appreciate all of this, then it’s all for naught. We just need to guide them in the right direction and emphasize things that are critical over things that are conventional. Just because the guy next door calls you and says, ‘How did you perform in the last quarter?’ that’s not really how to measure the health of the pension fund,” he said.

By Chris Butera