San Francisco Pension ‘Under No Obligation’ to Follow Jury Directives

A civil grand jury’s scathing report on the San Francisco’s employee pension system has no legal sway over its investment strategies, according to the former president of the California Grand Jurors’ Association.

(August 24, 2012) – A San Francisco jury can tell the city’s employee pension system to change its “volatile and risky investment policies,” but according an expert in the state judicial system, the fund does not have to listen. 

Or, more specifically, San Francisco Employees’ Retirement System (SFERS) board members have to listen and respond to the jury’s report, but are under no obligation to follow its advice. 

“The grand jury has no authority to enforce its recommendations,” Jerry Lewi, a long-time officer and former president of the California Grand Jurors’ Association, told aiCIO. “Their conclusions are strictly that: recommendations. But the power of persuasion is very significant, and a large portion of jury recommendations are accepted.” 

A 19-member civil grand jury investigated SFERS in reaction to weak returns and losses over the last five years, and its concluding report rails against the fund’s investment policies and decision not to undertake a formal “‘failure analysis subsequent to the funding loss suffered in 2008-2009.” The jury, which Lewi said is “made up of people from all walks of life,” issued a list of six recommendations for the SFERS’ investment team, including a lower rate of expected return, greater transparency and openness, more thorough risk analysis and “less volatile and risky investment policies that would attain sufficient returns” for members. 

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Lewi acknowledged that jurors are “not expected to be experts” in the subject they are investigating. “I would find it hard to think that a grand jury could make specific investment recommendations. If a report said, ‘You should be investing in stocks instead of bonds,’ it would not be appropriate, in my judgment.” 

While the jury’s advice is not legally binding, it does engage closely with questions of risk analysis and asset allocation. Lewi said the pension board is legally bound to answer each piece of advice by agreeing, proving its already been integrated, requesting more time to study the recommendation (to a maximum of three months), or refusing and defending why. 

SFERS is in the process of reviewing the report and preparing its responses, according to a statement. 

In California, a civil grand jury can investigate any municipal or county pension fund as often as it would like. Nevada is the only state with a similar, albeit less powerful, system.

Ingredients for Successful Investors: 'Time, Capital, Fortitude'

Legg Mason Capital Management's Michael Mauboussin warns investors to manage expectations.

(August 23, 2012) — Equity investors must distinguish between fundamentals and expectations, says Michael Mauboussin, chief investment strategist at Legg Mason Capital Management.

In other words, the key to generating excess returns is the ability to distinguish between price and value. Therefore, the most basic question investors must always answer: what’s priced in?

Mauboussin writes: “The key to successful investing, then, is to explicitly distinguish between fundamentals — the value of the company based on financial results in the future — and expectations — the market price and what it implies about those results. This is really difficult for at least a couple of reasons. The first is that normal humans prefer to be part of the crowd and that preference is what simultaneously leads to market inefficiency and an inability to take advantage of it.”

According to Mauboussin, the natural tendency among investors is to blur the distinction between fundamentals and expectations. He notes that when fundamentals are good, investors want to buy; when they’re bad they want to sell.

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He continues: “At this point, there should be no doubt that price and value diverge — and sometimes significantly. The problem is in taking advantage of it. And therein lies the key: The very factors that cause market inefficiencies make them difficult to exploit. That’s why finance professors are so smug when they condemn active money managers — the professors don’t doubt the existence of inefficiencies; they doubt the existence of investors who can systematically exploit those inefficiencies (especially after costs).”

Despite the skepticism of active managers, a 2011 paper co-authored by Robert Jones of Arwen Advisors notes that active management will always have a place in “mostly efficient markets.” And while many academic studies indicate that the average active manager doesn’t add value, Jones told aiCIO, “Its [it’s] the combined activity of all these active managers that keep markets efficient and thereby hard to beat, and efficient markets mean better capital allocation, and thus greater growth and wealth for society as a whole.” He concluded, “To reap this huge benefit, markets must encourage active management, which they do by heaping huge rewards on SAMs. Our paper also highlights that it may be possible for fund investors to identify superior active managers (SAMs) in advance based on various metrics and characteristics.”

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