Want Better Governance From Unlisted Funds? Tell Them.

(October 25, 2013) — Institutional investors must challenge board directors of unlisted funds if they are to see an improvement in transparency and governance, a campaigner has said.

Charlotte Valeur, director of the Global Governance Group, told aiCIO that while campaigners were working to encourage improved governance on unlisted funds’ boards, the truth was that money talked and they would be far more likely to listen to investors.

These funds could include smaller, segregated, specialist funds, rather than those pooled funds run by larger, more well-known fund managers.

“We are pushing for the unlisted fund space to give some level of transparency—even just one page detailing the board members, where meetings are held, and what was discussed—that would be start,” she said.

For more stories like this, sign up for the CIO Alert newsletter. 

The drive for these basic pieces of information has come from Valeur’s conversations with large institutional investors, including Railpen and USS in the UK.

“Unlisted funds need to be aware that if they want institutional capital, they’ll need to offer good governance from the start,” she continued.

Examples of poor fund governance were plentiful in the industry, Valeur revealed. Boards with temporary chairmen, boards filled entirely with family members and friends, and directors with more than 200 directorships to their name were all pointed to as examples of bad practice she had come across.

To help in her mission to bring unlisted funds into line, Valeur has appealed to institutional investors to ask five hard-hitting questions of their unlisted funds’ boards.

These are:

1) Ask about the composition of the board. Fund boards should have more than one independent sat on them, be experienced in the industry, and have regular board meetings. Investors should quiz the fund about what is discussed in the meetings, whether summaries are distributed to investors, and whether they meet their auditors separately from their investment managers.

2) Ask what the board processes are—if they meet less than once a year, as if there are little or no formal processes in place that is a good indicator of how seriously they are taking their role. An annual letter describing the board’s practices should be a bare minimum.

3) Ask how many directorships each board member already holds. “If something goes wrong, you need to make sure they have enough time,” Valeur advised. Ask them to disclose any remuneration for the role—if they’re not being paid at all, that could be a warning sign.

4) Determine who has voting rights to keep members on the board. In many cases it’s only the investment manager with the rights, leaving investors powerless to remove poorly performing directors.

5) Ask to speak to them directly. “If they won’t speak to you, you’ve got to question why,” said Valeur.

A white paper has found an increase in unfunded liabilities in Massachusetts’s already underfunded public pension plans when raising their COLA base.

(October 24, 2013) — Raising the cost-of-living adjustments (COLA) base in state pension funds would massively increase unfunded liabilities and appropriations over the next 20 to 30 years, according to a paper.

A white paper by the Pioneer Institute for Public Policy Research found that due to a series of regulations passed that allowed Massachusetts pension funds to increase the COLA base in increments of $1,000 up to a maximum of $18,000, state and local pensions could face significant rise in liabilities, of more than $1 billion, which could be detrimental to already underfunded plans.

COLA bases were designed to ensure retirees’ benefits remained consistent to the rate of inflation over time, the authors said. However, the Massachusetts public pension system’s COLA does not adjust for inflation—instead, it allows each retirement board to increase up to a maximum of 3% annually, only to a $12,000 base.

This system made the real value of future benefits uncertain, according to the paper, depending on the rate of inflation and pension size. Most likely, Massachusetts’s pensioners found their purchasing power decreasing over time as the COLA failed to adapt to inflation—losing up to 50% during their lifetimes.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

“There is no clear answer about whether the [Massachusetts’s] COLA system is unfair to employees and retirees,” the report said. “However, it is clear that changing the COLA to track inflation more closely would cost state and local governments.”

Massachusetts’s retirement funds’ unfunded liability equaled more than $6 billion, or only 58% funded, research found.

The paper concluded that if every local system in Massachusetts increased the COLA base to $13,000, liabilities would increase by $2,300 per pensioner, resulting in a total rise of about $203 million. However, since most pension plans do not have enough money invested, they would result to spreading the payments over a 20-year duration, amounting to $470 million.

If every state retirement system in Massachusetts raised the COLA to $18,000, the paper calculated an estimate of $1 billion increase in liability—an appropriation of an extra $2.5 billion over the next 20 years.

Despite such exorbitant impact on plans’ liabilities, the study said 45% of local retirement boards have already raised the COLA base as of 2013.

These changes in Massachusetts’s legislature and movement in COLA base stood out among a sea of other American public pensions’ decisions to lower COLA.

aiCIO reported in August that Illinois’ legislators have proposed to cut the automatic 3% annual increases in COLA and instead link the raises to inflation, to settle its serious underfunding. The state also suffered a downgrading by the ratings agency Fitch from “A” to an “A-“.

Rhode Island pensions plans also made headlines when the state treasury identified COLA as “the most expensive aspects of the current pension system (continuing to pay out COLA may deplete the pension und if the 7.5% investment return assumption is not achieved).”