The recent approval of new incentive compensation guidelines for investment and other staff by the board of the Alaska Permanent Fund Corporation (APFC) runs the risk of critical news headlines—a perennial risk faced by publicly funded investing institutions when they move to compensate financial-market professionals on staff competitively. But so far criticism of the initiative has been muted. Some observes point to the process the fund used to formulate the compensation scales as one reason for the silence of potential detractors. This, they say, may be an indicator that the fund’s compensation formulation process was the correct one for it and other similar public funds. The new compensation guidelines must now await approval by the Alaska State legislature.
Also, once the fund’s FY19 budget is enacted on July 1, APFC will begin recruiting for 10 new staff positions: four investment positions and six middle- and back-office support positions. “Moving more investments in house requires an increased investment in both the investment staff and those that offer investment support, such as IT, accounting, trade operations and administration. The investment positions are two investment officers and two investment associates,” according to a spokeswoman for the fund.
Pension funds’ primary driver for bringing on internal management is to increase net returns by reducing the cost of investment management, particularly as return expectations in today’s markets are lower than in the past. Most public pension plan sponsors understand, however, that there are headline risks with internal management, and seek to take steps to have strong governance in place and communicate to stakeholders that they are taking on the challenge to improve returns, according to Randall Miller, a principal at Funston Advisory Services, an advisor to public retirement systems in the areas of governance, operations and risk intelligence. He continued: “Many funds that do not adopt internal management choose that path because they see too many governance hurdles; for example, an inability to hire the right staff or make appropriate investments, or insufficient autonomy in other areas.”
“As we move towards implementing an incentive compensation policy, it will be subject to governor and legislative approval,” the APFC spokeswoman explained. The fund plans to propose the new compensation guidelines to the state’s governor and legislature for passage during the FY20 budget process. “APFC strives for a compensation program that competes well in the market and motivates all employees to bring their best efforts to the scope of their job responsibilities. The program provides a systematic means of tracking, measuring, and compensating employees and allows flexibility for APFC to act quickly,” she said.
The spokeswoman referred to APFC’s five-year strategic plan for 2017-2021 as illustrative of the fund’s staffing objectives. Under the plan, the fund has prioritized two elements: developing best-in-class investment management capabilities, partnerships, and geographic reach to maximize investment returns; and enhancing talent and staff across APFC. “One of our goals in support of those priorities is to implement a competitive incentive compensation program by October 2019,” she said.
With its May 24 approval of the compensation guidelines, the board of the Juneau-based $65 billion sovereign wealth fund observed in internal documents that “…It is imperative that APFC is in a position to attract, incent, and retain staff at all levels and in all positions.” It added that “because the level and complexity of internal investment management at APFC and the value-added and savings achieved by this internal management have grown significantly in the last five years, the Board feels strongly that fair and competitive compensation for APFC staff needs to evolve and grow to acknowledge and foster this successful result.”
Many public retirement systems manage assets internally and many do it quite effectively. But funds are not likely to get kudos for doing so because, much like a goalie in hockey, if you do well, you’re simply doing your job!
Varying Compensation Levels
“We see a very wide variety of compensation levels among investment staff at public funds,” according to Keith Brainard, research director at the National Association of State Retirement Administrators (NASRA). “Often, that disparity is based on state compensation rules for public employees. Some states allow funds to have their own comp structures, others do not. The thing is, though investment specialization is now often part of a public fund’s staffing needs, in some states some funds find it is very difficult to compensate their staff competitively, while others are able to do it,” he said. He added that “sometimes, we see managers of public funds that have to deal with legislators who don’t like the fact that some public employees are making a lot more in salaries than others—they resent it. But at the same time, they wouldn’t think twice about a fund writing big checks to external asset managers.”
When asked if the APFC board has any concerns about possible criticism in the press or a backlash or rejection from Alaska legislators based on the heightened compensation levels it is proposing for its investment staff, the fund responded by email only that “The APFC looks forward to working with the Governor and Legislature on forwarding this priority during the upcoming session.”
APFC’s New Comp Guidelines
In March of 2017, APFC hired Stamford, CT-based compensation consultant McLagan to execute a review and develop an incentive compensation plan for the fund. At the December 2017 board meeting, the board adopted updated base salary pay bands for each position as a result of that review. The adjustments warranted by the new base salary bands were incorporated into the FY19 budget request for APFC, according to fund documents.
The new comp guidelines are part of a strategic five-year plan embarked upon by APFC beginning in late 2016. The plan comprises five priorities, according to fund documents:
- Gain greater control of resource allocations;
- Optimize APFC’s operational processes and use of financial networks and resources;
- Develop best-in-class investment management capabilities, partnerships, and geographic reach to maximize investment returns;
- Enhance talent and staff across APFC;
- Implement a competitive incentive compensation program for FY19 by Oct 2019.
Recognizing that APFC competes with a broad range of firms for investment talent, McLagan assembled pay data from three peer groups:
- S. and Canadian public funds with internal/direct asset management capability;
- Private sector investment organizations with AUM less than $100 billion, including advisory firms, banks, insurance companies, endowments, foundations, and corporate plan sponsors with;
- A blended peer group: 75% public funds and 25% private-sector firms.
Among the resolutions made by the board at the May 24 meeting are that compensation for APFC staff should be commensurate with its peer equivalent. (see McLagan table tables tk).
The board also resolved that APFC staff responsible for administration and operations, including the Director of IT, Administrative Services Director and the Human Resources Manager should be compensated at competitive regional salaries, eligible for annual merit increases, targeted at median total cash compensation at APFC’s peer equivalent, and that APFC staff responsible for the investment, including the Chief Investment Officer Russell Read, should be compensated through a base salary plus annual incentive compensation targeted at median total cash compensation at APFC’s peer equivalent. APFC executive management, including the Executive Director Angela Rodell, Chief Financial Officer Valerie Mertz, Chief Operating Officer Robin Mason and General Counsel Chris Poag may be subject to incentive compensation at the discretion of the Board.
APFC’s Investment Operations
In September 2016 APFC announced it would seek more investment staff, promoting and hiring externally. At the time, internally managed assets accounted for 24% of overall assets; the goal was to increase it up to 50% over the next five to 10 years. As of June 30, 2017, 38% of APFC’s assets were managed internally and 62% were managed externally. In the prior year, 34% of its assets were managed in-house and 66% managed externally, according to a presentation the fund delivered the Alaska State Legislature in February 2018.
Early last year, AFPC hired three investment professionals to expand its internal management to half of its total assets. Travis Brown joined the fund’s private equity and special opportunities team from Goldman Sachs as an investment officer. Ben Chang was hired as a senior associate covering private income and hedge funds. Prior to joining the fund, Chang spent four years working in private equity and private equity consulting with Boathouse Capital, based out of Philadelphia, and Stax Inc., based out of Boston. And Tom O’Day joined as a fixed-income investment analyst. He previously worked for the insurance and reinsurance firm Endurance for six years as an investment analyst. Brown and Chang have since moved on to pursue other opportunities, according to the spokeswoman, adding that the fund is currently recruiting for a private equity associate.
APFC’s investments gained 8.86% through the third quarter of fiscal year 2018. The fund ended March 31, 2018 with assets under management totaling $64.6 billion, and returned 8.35% over the last five years and 6.52% over the last 20 years.
Largely as a result of ever-increasing pressure on public funds to operate more cost-effectively and to maximize investment returns, several large public funds have taken up the mantle of in-house asset management in recent years. According to Funston Advisory Services, 70 U.S. public pension funds with $10 billion or more in assets, have in-house investment management. Just under half manage a portion of their non-cash assets internally, and larger funds are more likely to have internal asset management. (see funston table on public funds table below) .
“For larger public pension funds, for example those over $25 billion in assets under management, we would call adoption of internal investment management, as well as increasing the level of internal management where it already exists, a trend, Miller said.
The approximately $117 billion State of Wisconsin Investment Board (SWIB) and the approximately $147 billion Teacher Retirement System of Texas (TRS) are two recent examples of large pension funds that have increased their internal investment operations. In an April 2017 press release, SWIB stated: “SWIB keeps costs low because it hires the best people—based on their ability to meet aggressive investment targets and add value to the trust funds—to manage funds in house at a much lower cost. SWIB staff manages almost two-thirds of the assets of the [Wisconsin Retirement System] for one-fifth of what it would cost to pay external managers for the same work. SWIB’s greater reliance on internal management saves $75 million per year compared to what similar funds would pay to manage the same assets. This is more than SWIB’s $53 million total annual operating budget including all staff compensation.”
In March TRS, proposed a plan to almost double the size of its in-house investment team in an effort to lower costs. The fund’s CIO, Jerry Albright, made a case to the pension’s board for hiring 120 people over the next five years. That would increase the size of the in-house investment team to almost 270. According to a spokeswoman for the fund, “TRS Investment Division is considering a plan to maintain current competitive advantages and total returns as well enable us to manage cost structures that increase net alpha generated by TRS Investment programs. In order to do so, we are considering increasing internal asset management capabilities in the public markets and increasing principal investment activities in private markets (Private Equity, Real Assets, and Energy, Natural Resources and Infrastructure (ENRI). Currently, TRS is targeting to increase the investment team by 63 and to realize a potential fee savings of approximately $600 million over the next 3 years.” New hires are planned for September this year, but the details and timing of those hires are still under discussion at the fund.
There is one primary driver for internal management, i.e., improve risk- adjusted net performance of the fund through lower costs, according to Funston Advisory Services. The firm points to other potential benefits, which include:
- Enhanced staff recruiting, workplace culture and overall Fund image
- Improved “closeness to the markets”
- Catalyst for building overall capability of the organization
- Can facilitate unique investment approaches, such as ability to take advantage of temporary market dislocations in an opportunistic manner
- Fees that would otherwise go to out-of-state investment firms instead support the local economy, enhancing long-term plan stability
According to NASRA’s Brainard, boards have fiduciary and moral responsibility to act in the best interest of their funds and their fund’s beneficiaries. So, sometimes these funds embark on building internal investment resources even in the face of potential headline risk, NASRA’s Brainard said. “But if you’re going to do that, then you must perform,” he emphasized. “Many public retirement systems manage assets internally and many do it quite effectively. But funds are not likely to get kudos for doing so because, much like a goalie in hockey, if you do well, you’re simply doing your job!”