Wyoming Pension: Time for a Fund Manager Fee Structure Makeover

The $6.5 billion Wyoming Retirement System's John Johnson and Jeffrey Straayer say that fee structures for fund managers need to shift control into the hands of asset owners -- the chief investment officers and other investing heads of pensions.

(July 26, 2012) — The $6.5 billion Wyoming Retirement System says it’s time for “capital owners,” or public pension funds more specifically, to change the way they compensate their fund managers, because as of now, the managers are often the ones getting most of the benefits — even when they underperform.

Thus, according to the public pension fund’s John Johnson, chief investment officer, and Jeffrey Straayer, a senior investment officer, the Wyoming scheme is changing its methodology of fund manager compensation. It has introduced a revised fee structure in a request for proposal (RFP) in March and is expecting implementation by mid to late August. While traditionally, fund manager fee structures used by pension funds lead to overpaying managers when they’re doing well, managers maintain that payment when they’re underperforming, according to Johnson. Most asset owners have fund manager fee structures that include a high fixed active fee with a performance fee added to it, which leads to a tendency among fund managers to index and gather assets to attain the highest fees, Johnson said. “That business model shifts risk to the pension fund rather than the risk being on the fund managers,” he said.

Consequently, Johnson and Straayer are introducing the idea of a performance fee bank — an idea they say that was generated by conversations with a range of money managers, particularly Goldman Sachs. The concept in a nutshell: If a fund manager employed by the Wyoming Retirement System generates return above a certain benchmark, they are paid for it. The Wyoming fund’s new fee structure creates a performance fee bank in which fund managers are paid a base fee that is near passive as opposed to an active base fee that rewards managers if they generate returns that match the benchmark.

“We wanted to create a holdback period rather than a clawback period,” Straayer noted. “With clawbacks, if fund managers are paid in excess of what they should have been paid, a pension’s investment head must ask them to repay what’s been lost, which is a problem.”

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Johnson added: “Our experience has been that managers generate alpha and then lose it all, yet they still get paid a high fee because we need to pay an active management fee for passive returns.”

The Wyoming Retirement System, however, wants to pay managers when they consistently beat the market. “The performance fee bank is essentially a high-water mark, because if they don’t outperform the index, the fee bank is reduced. If it goes below zero, managers must build the fee bank back up before we pay out a performance fee,” Straayer asserted.

For Wyoming’s pension fund, the key for fund managers proving their value is only by demonstrating sustained returns, the two pension heads said.

“We’ve spoken with a number of pension folks — they’re intrigued and some of them are taking it to their managers. It’s still a new concept,” Johnson noted. “The reality is that the business is changing, and if managers want to be successful, they need to give value to capital providers.”

(July 26, 2012) — The mayor of an ailing municipality says he has a novel investment opportunity for the city’s underfunded pension plans—$16 million of the city’s own debt.

The mayor of Scranton, Penn., floated the proposal in a letter to the Scranton Composite Pension Board as a way for the destitute city to meet its payroll. If the board accepts the deal, the city’s four pension plans would purchase $16 million of Scranton municipal bonds with a 10-year duration and offering a yield of 8%.

“Please allow this letter to serve as a formal request to the Pension Board to consider investing the sum not to exceed Sixteen Million Dollars into taxable City of Scranton Municipal Bonds,” wrote Mayor Christopher Doherty. “The cash infusion from the bond proceeds allows the City to meet current year obligations for payroll and debt service. This investment proposal includes a fixed rate of return on the investment of 8% [which] will greatly assist future funding in order to maintain the corpus of the fund.”

While there is no legal barrier to the investment, there remain deep concerns over whether buying a large chunk of the city’s debt is a wise investment for the pension plans. “Just because it’s not illegal doesn’t mean you have met your fiduciary obligations,” pension board solicitor Lawrence Durkin told the Scranton Times-Tribune.

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As it turns out, the financial situation of Scranton’s pension funds is little better than that of the city. According to data collected by the Public Employee Retirement Commission, the agency that oversees local pension plans in the state, Scranton’s pension plans had assets of about $60 million and liabilities of more than $140 million as of July 2010. The agency lists the pension funds as “severely distressed” because of their lack of funding. Furthermore, the pension funds’ consultant BNY Mellon warned recently that if equity prices do not improve, the funds could run out of money within five years, the Times-Tribune reported.

Scranton’s mayor made headlines this month when he slashed the salaries of city workers—including his own—to minimum wage. Scranton unions have initiated legal action to reverse that move, and Doherty faces a contempt of court charge for going through with the pay reduction after a judge forbade it.