Governance Guru Applauds CalPERS’ Move
The decision last week by the board of the $350 billion California Public State Retirement System (CalPERS) to change its governance policy to make the CEO solely responsible for hiring, evaluating and, if necessary, terminating the chief investment officer, sits very well with Rick Funston, managing partner at Funston Advisory Services, an advisor to public retirement systems in the areas of governance, operations and risk intelligence. “This reduces ambiguity about the CEO’s overall responsibility and accountability for the performance of the System,” Funston said.
He explained that CalPERS’ decision provides for clear and direct communication and accountability. “It places the CEO in the position of leadership with experienced professional staff, whose focus is to implement board-directed investment strategy and goals. The CIO is directly accountable to the CEO and the CEO is accountable to the board.”
Beyond confirming the decision, a CalPERS’ spokeswoman said she could provide no further comment.
CalPERS’ decision was not the first decision of this type by a U.S. public pension plan. Indeed, the move is part of a growing trend among public pension plan boards to delegate more responsibility to their staff who have expertise in key specialized areas, such as investments, Funston said. “Its [decision] is evidence of a durable trend of increased board focus on strategy vs. tactics and the responsibility for the day-to-day management of staff.”
Some of the most exemplary pension institutions regarding board autonomy and delegation of authority to staff are Canadian funds, but they operate under a very different legal framework. Funston pointed to the Ontario Teachers’ Pension Plan (OTTP) and Ontario Municipal Employees Retirement System (OMERS), as examples.
U.S. public employee pension systems all operate within different legislative frameworks, which generally allow their boards less autonomy. U.S. funds also vary in how much authority they choose to delegate to their chief executives, Funston explained. “Investment governance is all about decision-making. What are the key investment decisions? For example, asset allocation, risk appetite, and investment policy are strategic issues that can only be decided by the board. How much autonomy does management then have to execute those directions and how do they exercise it?”
Until 2011, CalPERS had four officers who reported directly to the board, namely the chief actuary, the general counsel, the CIO and the CEO. In 2011, Funston Advisory Services recommended that the system reduce the number of staff that report directly to the board to one, i.e., the chief executive. In 2012, the CalPERS board reduced the number of direct reports to two: the CEO and CIO, with the chief actuary and the general counsel reporting to the CEO. Shortly thereafter, the board consolidated the authority of the CEO by making the CIO a direct report to the CEO. The board remained involved in hiring, however, evaluating and terminating the CIO. With last week’s move, the CalPERS board completed the transition by also delegating sole authority for hiring and termination the CIO to the CEO.
CalPERS is not alone
A growing number of U.S. public pension systems are looking at the feasibility of delegating tactical investment decision-making, in general, to investment experts, and looking at prudent ways to implement that structure with clear accountability to the CEO and to the board. “What they all have in common is that they all have a mission to create and protect the value of their fund,” Funston said. When they delegate, they must do so prudently. Boards need insights to provide effective oversight, and they need independent verification that management’s reports are reliable.”
In 2012, the Board of School Employees Retirement System (SERS) of Ohio moved to a governance structure, in which a staff committee now approves new investments. The board approves investment strategy, but investment decisions are delegated to a staff investment committee chaired by the CIO that comprises voting investment officers as well as non-voting representatives from executive, legal, finance and enterprise risk functions. The board approved the change for two reasons, according to a spokesman for the system: 1. “Staff are in a better position to make investment decisions, they are responsible and accountable to the board for these decisions,” and 2. “It makes the investment department more agile – sometimes when new opportunities arose, there would be a delay because education sessions had to be made at the board level before approval was given.” The board maintains oversight of the investment department as they set policy guidelines and risk targets and approve the annual investment plan.
Smaller organizations typically have more board involvement because they have less staff. As portfolios and organizations grow and become more complex, the board needs to become more strategic, Funston asserted.
“Fundamentally, the question is whether the board is being prudent. It can be considered prudent if it has a robust processes for selection, instruction, reporting, monitoring, questioning and evaluating staff qualifications, goals and results. Given that public pension board members are typically part-time volunteers, with very different day jobs (even if they are financial experts), it may be imprudent for them not to delegate,” he said.
He concluded observations with an anecdote to make a point: “I once hired a carpenter to build me a customized desk at my home, and I closely supervised his every move. Eventually, he turned to me and asked: ‘Why have a dog if you’re going to do all the barking?’”