New York City Pension with Big Plans
Larry Schloss, CIO of the $120 billion New York City retirement system and former private equity honcho, is trying to transform the way the U.S.’s fifth-largest pension plan invests its money.
A SMALL CONFERENCE ROOM TUCKED AWAY ON THE 22ND floor of a municipal building in downtown Brooklyn might seem like an unlikely location for high political drama. Yet the investment board meeting of the New York City Employees’ Retirement System held there on November 15, 2011, proved to be precisely that.
The previous month New York City Comptroller John Liu, whose office manages $120 billion in pension assets for the city’s firefighters, police, teachers and other public workers, had unveiled a slate of reforms that would, if enacted, represent the greatest change in how the retirement system has been run for more than 70 years. At the heart of the proposal: a plan to create an independent asset management entity and put in place a single board to supervise it, taking authority from the five boards and 58 trustees that currently oversee the five separate funds that make up the New York City pension scheme, of which the $41.6 billion NYCERS is the second largest.
Liu’s first deputy comptroller, Eric Eve, had come before the NYCERS board to explain the plan in more depth. Not all of the 11 members were happy with the proposals. In particular, they worried that the new structure would give Wall Street control of their hard-earned pension dollars. In the
aftermath of the failure or near-failure of banks like Lehman Brothers Holdings, Bear Stearns Cos. and Citigroup — Eve’s former employer — while taxpayers bear the burden of bailouts, and some bankers and money managers pull down multimillion-dollar salaries, Wall Street lacks credibility among pension beneficiaries and their representatives. Just two weeks earlier broker-dealer MF Global Holdings had filed for bankruptcy, the result of an ill-fated $6 billion bet on European debt by its CEO, Jon Corzine, a former head of Goldman Sachs Group. Once the gold standard of investment banking, Goldman is now regarded by many on Main Street as a “vampire squid” sucking the lifeblood out of the economy, to paraphrase Rolling Stone journalist Matt Taibbi.
At one point on the morning of November 15, Larry Cary — the pugnacious attorney representing Transport Workers Union Local 100 on the NYCERS board — reminded Eve and the others in the room that Michael Bloomberg, the city’s billionaire mayor and a backer of Liu’s proposed reforms, had directed the evacuation of Occupy Wall Street protesters from a park in Lower Manhattan the night before. Those protesters were part of a national movement objecting to the widening gap between the top 1 percent of wage earners and the rest of the population, which controls only 10 percent of the U.S.’s wealth.
“I have sat in pension fund meetings for 25 years,” Cary said, “and I have never questioned the sincerity, the level of education and the goodwill of a series of investment advisers about what the pension fund should do with [its] money.” But, he continued, “I have a great distrust for what I call the Wall Street mentality, which is, ‘We know better than the people who don’t know the technology that we have, who didn’t go to Wharton, who didn’t go to Harvard Business, who didn’t spend their lives making money.’ ”
The blue-collar trustees sitting around the table, Cary added, “spent their lives doing things for people and making a living in many other ways. And they bring a perspective and a judgment to the process. The concept of turning $120 billion over to some Wall Street types so they can make the decision —”
“This is not what is going on here,” Eve interrupted, raising his voice for the first time during a meeting already into its third hour. “This is not what is going on here,” he repeated, addressing the NYCERS chairwoman, mayoral appointee Ranji Nagaswami, a former CIO at $400 billion-in-assets money manager AllianceBernstein and a current member of the investment advisory board for Yale University’s $19.4 billion endowment. “That is not what I have said.”
“We are talking about eliminating public accountability,” insisted Cary.
“No one has said anything here about outsourcing $120 billion to Wall Street executives,” Eve interjected, waving his finger for emphasis. In fact, he explained, it was quite the opposite: “We want to pay public employees some portion of the $440 million that you paid Wall Street last year. We want to build in the world’s financial capital a best-in-class, public employee, staff-driven organization. This is not about outsourcing anything to Wall Street.”
The representative for the International Brotherhood of Teamsters, the other union that had been vocal in its objections, was unconvinced by Eve’s assurances. NYCERS board member Gregory Floyd, the outspoken president of Teamsters Local 237, raised concerns similar to Cary’s.
“I am afraid that we have real capital right now, $120 billion, and tomorrow we could have nothing and no say in it,” Floyd said. “In 20 years I want to be a retiree from New York City, and I don’t want to get a letter in the mail saying, ‘Mr. Floyd, due to our poor performance, your pension benefits have been cut in half.’ ”
Throughout this exchange, sitting in Yoda-like silence a few seats down from Floyd and Cary, dressed in his usual white button-down shirt, tie and glasses, was Lawrence Schloss. As a deputy comptroller and CIO of the Bureau of Asset Management, Schloss, 57, is responsible for trying to steer a prudent investment course for the $120 billion in city pension funds — hardly an easy job during the best of times. Up until two years ago, when he was appointed by Liu, Schloss was one of the Wall Street 1 percent. He has an MBA from the University of Pennsylvania’s Wharton School and more than 30 years of experience working in private equity.
“I don’t do the politics,” Schloss had told me a few days earlier. “I just focus on the investments.”
During the NYCERS meeting, which I watched from a row of seats against one wall of the conference room reserved for a handful of journalists, it struck me that what Schloss had told me seemed true. Floyd’s comments were among the last on the pension reform proposal. After that the board took a break, Eve left, and when the meeting resumed, Schloss took the helm to discuss the latest results in the investment portfolio. None of the hostilities carried over from the fractious exchange; everyone listened respectfully to the CIO’s insights. The board members appeared to trust Schloss as a steward of their money and their future. But at public pension funds, politics is never very far away. And although Schloss might want to leave the political side of the comptroller’s business to Eve and others, he cannot always avoid the fray.
When Liu took office in January 2010, the New York City retirement system was in lousy shape. Years of rising pension deficits and investment underperformance, combined with a post-financial-crisis falloff in local and state tax receipts, meant that there were both huge pressures and major incentives to reform the system. Hiring Schloss was a coup for the new comptroller and a significant step toward creating a better-run, more professional investment management unit to oversee the city’s retirement assets. In two years Schloss has done wonders with the pension fund. But many, including Liu, believe that for the improved returns to be sustainable, the retirement system requires a major overhaul. That is what the comptroller’s office is seeking to achieve with the proposed reforms, but in the current political and economic climate, success is far from certain.
Public pension deficits are growing larger across the U.S., but many states and municipalities lack the funds to meet them. Take California, home to two of the largest U.S. public pension funds, the $229.5 billion California Public Employees’ Retirement System and the $144.8 billion California State Teachers’ Retirement System. The current combined underfunded status of CalPERS, CalSTRS and the $41.9 billion University of California Retirement Plan is $290.6 billion, more than three times the state’s general budget, according to a December report by the Stanford Institute for Economic Policy Research.
The report recommends that California consider moving to a defined contribution plan. So contentious are its findings and methodology that California Treasurer Bill Lockyer resigned from the Stanford Institute’s pension advisory panel. In New York, although the $149.6 billion New York State Common Retirement Fund is close to fully funded, Governor Andrew Cuomo has proposed the creation of a controversial new tier to the state pension system — designed to save both New York City and the state money — for new beneficiaries that would shift some of the payment obligations away from the state and include a defined contribution option.
There are those in organized labor and elsewhere who fear that the current low-interest-rate, tough economic environment is being used as an opportunity, or even as an excuse, to force through changes that would dismantle the entire defined benefit system. It is — as Floyd, who had threatened to run for New York City mayor in 2013 on the pension issue, said during the November NYCERS board meeting — a topic where passions run high.
For the fiscal year ended June 30, 2010, NYCERS had a funding ratio of 77 percent, meaning it had 77 percent of the assets necessary to meet its future liabilities. The $41.8 billion New York City Teachers’ Retirement System had a funding ratio of 63 percent, the $24.6 billion New York City Police Pension Fund was at 71 percent, the $8 billion New York City Fire Department Pension Fund was at 57 percent, and the $2.9 billion Board of Education Retirement System was at 71 percent. As of December 31, 2009, the five city funds had a combined ten-year annualized return of 2.94 percent, putting them in the bottom decile of the Wilshire Associates Trust Universe Comparison Service.
During the ten years that Bloomberg has been mayor, the city’s required annual contribution to the pension funds has increased from $1.5 billion to $8.4 billion. Pension costs now account for 14 percent of the city budget, up from 1.8 percent in 2001. “If you look at the arithmetic, it seems pretty clear,” says Robert Steel, deputy mayor for economic development and a key Bloomberg administration point person on the pension issue. “The overall level of commitment that we have made to pensions is just not sustainable.”
Part of the solution lies in better pension management. That is what Schloss was brought in to do. A Queens, New York–born son of an obstetrician, Schloss was inspired to work on Wall Street by his Dutch refugee grandfather, who in his retirement came by on weekends to talk stocks with Schloss’ dad. In high school Schloss got a summer job working in the back office of SocGen Swiss on Wall Street. After earning a BA in economics from Tulane University in New Orleans, he went directly to Wharton to get his MBA and then in 1978 landed a job as an associate investment banker at Donaldson, Lufkin & Jenrette, where he went on to help build the firm’s private equity business.
“Larry is an unusual guy,” says Hamilton (Tony) James, president and chief operating officer of private equity giant Blackstone Group and Schloss’ former boss at DLJ. “He is a business-builder and a very good investor; those two attributes don’t always go hand in hand.”
A member of the board of trustees of the New York Police & Fire Widows’ and Children’s Benefit Fund for many years, Schloss has always remained loyal to New York. So when Liu’s team came calling, he was ready to swap his posh Park Avenue office at Diamond Castle Holdings, a private equity firm he co-founded in 2004, for a dark, cluttered one in the warren that the comptroller and his staff occupy at 1 Centre Street in downtown Manhattan, complete with strip lighting, monochrome walls and an occasional mouse.
A comedown in interior furnishings was just one of many differences between the public and private sectors for Schloss, whose $224,000 annual salary today is a small fraction of what he earned on Wall Street. Suddenly, Schloss has gone from being his own boss to reporting not only to the comptroller but to the 58 trustees who make up the five city retirement boards and vote on everything from pension benefits and disability awards to asset allocation and manager selection.
“Most of the trustees have seen a lot of comptrollers and CIOs come and go,” Schloss told me the first time we met. They see themselves as the guardians of precious retirement assets, he went on to explain. They don’t take kindly to being told that some of what they have been doing is wrong.
After Schloss got his city job, he made a point of meeting with all the trustees, either one-on-one or in small groups, to introduce himself and get their views. He then set about changing the system. Bringing in new people and working with existing staff, he transformed the portfolio as well as some of the investment processes, such as how the system goes about selecting and hiring managers.
The results have been nothing short of remarkable. After languishing among the worst-performing public pension funds for a decade, the New York City retirement system returned 23.2 percent in the fiscal year ended June 30, 2011, its first full year under Schloss.
That was the best return of any large public fund in the U.S. during that period, but there needs to be a policy change for the investment improvements to stick. That is where Liu’s proposed reforms come in. The comptroller would give up almost all of his current authority over the investment management of the pension fund, one of the key responsibilities of the job. That puts him in conflict with certain elements of organized labor and other political offices in New York City. “We will not support a proposal that diminishes the role of the borough presidents in this process,” says John DeSio, spokesman for Bronx borough president Ruben Diaz Jr. “That is a nonstarter.”
Liu, 45, makes for an unlikely reformer. Last fall questions arose over the legitimacy of some campaign donations he had received in 2011. The situation worsened when one of his supporters, businessman Xing Wu (Oliver) Pan, was arrested in November by the Federal Bureau of Investigation for allegedly trying to get around contribution limits; the FBI’s investigation into Liu’s campaign finances is ongoing.
The controversy about Liu’s finances hit the headlines as I was reporting this story. During those months Liu and I attended a handful of the same events. Suddenly, I saw him everywhere, more often than not flanked by staff members. It was only when I finally met with him in his office that I started to understand his motivation for trying to push through pension reforms that would effectively reduce his power. “It is at the most fundamental level the right thing to do,” he explained to me one late-December afternoon. “It is also a necessary thing to do, especially when we are faced with rising pension costs. There is a way, with better investment returns, that pension costs can be reduced.”
IN 1857, NEW YORK CITY BECAME THE FIRST OF ANY U.S. municipality or state to offer workers financial security in their old age when it established the Police Life and Health Insurance Fund. Assets in the original fund came from the sales of unclaimed property, rewards, contributions and fines from violations of the blue laws that restricted commerce on Sundays. Originally, as financial journalist Roger Lowenstein writes in While America Aged, his 2008 book on the pension crisis, the benefit was only for policemen who had been disabled or the widows of officers who had been killed on duty. But in 1878 it was extended to all policemen who had served 25 or more years and had reached the age of 55. According to Lowenstein, “The fund was virtually insolvent right from the start.” By 1913 it was completely out of money and forced to depend on contributions from the city coffers. Still, by the 1930s pension coverage across America had been expanded to include firefighters, public workers and teachers, as well as federal employees.
Today’s New York City retirement system can be traced back to 1941. That was the year that legislators in Albany passed a bill unifying the city’s five retirement funds under the Bureau of Asset Management in the comptroller’s office.
Investing public pension money was simple enough in the beginning. Pensions invested in bonds and over time moved into equities. Starting in the 1980s they began diversifying into different types of investments — in particular, private equity, which with its need for long-dated capital and its high potential returns seemed like a perfect fit for these long-term asset owners. The flow of institutional money into this sector created a booming private equity business.
Schloss was part of that boom. Although Schloss was hired by DLJ to work in investment banking, his former boss James says he was more investor than banker. “The best investment bankers are natural salesmen; they can sell snowballs to Eskimos, and they have the gift of the gab,” James says. “Larry is substantive. He doesn’t have a lot of polish. And he is skeptical. That sort of personality makes for a good investor.”
As a partner and, later, chairman of DLJ Merchant Banking Partners, Schloss worked with some of the top pension plans in the world. That’s how he got to know James Leech, president and CEO of Ontario Teachers’ Pension Plan, a leading private equity investor. Ontario Teachers’ stuck with Schloss after Credit Suisse bought DLJ in 2000, and it followed him in 2004 when he spun out Diamond Castle from Credit Suisse.
“Larry is a no-nonsense person,” Leech says. “He is straightforward. He is not subtle from the perspective of saying, ‘That does not work; why would you do that?’ He gets right to the point, and we find that quite endearing.”
New York City’s retirement funds began investing in private equity in 1993. The equity bull market of the ’90s was good for public pensions, many of which became overfunded thanks to strong investment returns. As a consequence, however, states and municipalities often did not make their payments into pension coffers, and unions were able to negotiate improved benefits and payments. In New York in 2000, then-mayor Rudolph Giuliani and then-governor George Pataki struck an agreement with the unions that gave New York City a holiday from paying pension benefits in return for a ten-year reduction in how much union members would contribute to the fund.
Pension funds across the U.S. were hurt by the two and a half year bear market that followed the bursting of the dot-com bubble in March 2000. In the case of the New York City pension system, the terrorist attacks of September 11, 2001, had a particularly devastating impact. In addition to the pensions owed to the 366 active New York City firefighters and police officers and eight retired members who died when the Twin Towers collapsed, the city was responsible for providing benefits to the hundreds of firefighters and police officers who took medical leave or retired following the attacks. The total cost: $545.5 million, according to a 2002 report by then-comptroller William Thompson Jr.
The subprime mortgage collapse of 2008 and the subsequent economic maelstrom also took their toll on New York City’s pension system. At the same time, a pay-to-play scandal was unfolding at the state level. An investigation kick-started by Cuomo, who was then state attorney general, revealed that an investment official and fundraiser working for Alan Hevesi, who had been state comptroller from 2003 to 2006, had been taking kickbacks in return for contracts to manage some of the state’s pension assets. Hevesi is currently serving a one- to four-year prison sentence after pleading guilty to corruption charges. Before he was state comptroller, Hevesi was comptroller for New York City.
Hevesi and his associates were never charged with any wrongdoing for the period when they ran the city funds, from 1994 to 2001. But the state pension scandal was part of the background to the 2009 election for New York City comptroller. Then–city council member Liu, a former actuary, ran on a ticket of transparency and became the first Asian-American elected to citywide office in New York.
Liu says his treatment of the pension system is in keeping with his election platform. He has refused to take campaign contributions from investment managers running money for the pension funds or seeking to do so. He also has expanded the public section of the retirement board meetings — which in the past had disclosed very little — put in place live video streaming of the meetings and posted meeting minutes and materials online. (As someone who has reported on the New York City retirement system for more than a decade, I can attest that this is a very big change.)
The comptroller appoints the deputy comptroller, who is the CIO for the Bureau of Asset Management, often giving the position to a loyal supporter — not necessarily to a person with institutional investment management experience. Schloss’ predecessor Rita Sallis was the longtime deputy comptroller for public finance, managing the city’s budget before then-comptroller Thompson appointed her as CIO. But with concerns about the pension fund mounting at the time he took the comptroller’s job, Liu was encouraged by the mayor’s office to appoint someone with true investment expertise. Groups like the Partnership for New York City, founded by former Chase Manhattan Bank chairman David Rockefeller in 1978 to promote the city as the center of world commerce, finance and innovation, also lobbied Liu to appoint a seasoned professional.
He took their advice.
That is how Schloss, who had never met the incoming comptroller, found himself being offered the job by a member of Liu’s transition committee in December 2009. At the time, the private equity industry was in a major funk in the wake of the September 2008–March 2009 market meltdown. Schloss had been through private equity slumps before and wasn’t looking to leave Diamond Castle. But the deputy comptroller position was too intriguing an opportunity to turn down.
“If someone says, ‘How would you like to run the fifth-biggest pension retirement fund in the country?’ and you’re a local boy, how could you say no?” Schloss explains. “New York is the world’s financial capital. It deserves the world’s best pension fund.”
MARTIN GANTZ THOUGHT HE KNEW what to expect when he heard that Larry Schloss had been appointed deputy comptroller for asset management. A 24-year veteran of the Bureau of Asset Management and its current head of fixed income, Gantz had seen elected officials and their CIOs come and go. Each time a new comptroller named a new CIO, Gantz went through the same exercise.
“They call me in to the office and say, ‘We need to do an RFP,’ ” Gantz, 45, recounts, speaking in a shabby conference room in the Manhattan Municipal Building, which houses more than 2,000 public employees, including the staffs of the city comptroller, public advocate and Manhattan borough president.
Gantz is referring to the request for proposal commonly used by public funds to solicit new money managers to bid on an investment management contract. Gantz would tell incoming CIOs that the RFP process took at least a year. When they asked why it took so long, he would launch into an explanation of the city Procurement Policy Board rules. These rules require that any vendor seeking to do business with New York City make a bid through a request for proposal. The city picks the vendor from the list of submissions. This can take 12 to 18 months.
“It is the same rules if the city buys this pen or a paper clip,” Gantz says, holding up his pen. “These are PPB rules.”
The rules require the city’s five pension funds to choose only from managers that respond to an RFP. And though all five city funds have been advised by different investment consultants, these consultants do not, as they often do with pension plans, use their expertise to assist with soliciting bids beyond providing a comprehensive list of managers.
What this means for the retirement fund is that hiring new managers is a long, drawn-out process, and not always worth the wait. Changing any part of the investing program can be painstakingly slow — a huge challenge, especially in today’s volatile capital markets. “This is not a way to make money,” says Schloss. “The PPB process is about as nimble as an elephant.”
Typically, once Gantz explained the RFP process to an incoming CIO, the new investment officer threw up his or her hands. Not Schloss, Gantz says: “Larry looked at me and said, ‘Change the law.’ ”
Under the existing rules the bureau can devise a new process and, with the backing of the comptroller, get it approved by the Procurement Policy Board — and that is exactly what Schloss and his team are doing. In the new process, which recently began an eight-month trial period, the bureau is using the five pension funds’ investment consultants rather than relying on firms nominating themselves through RFPs. If Schloss wants to conduct a manager search in a particular asset class, he or one of his team members can go to the consultants and ask for their top managers in that asset class. The bureau then reaches out to managers that score well among several of the consultants and asks them to submit a bid. By simplifying the previous process, the bureau has already reduced the hiring time to seven months. Schloss is hoping that the new system will cut it to just three or four months and that it will be approved into law.
New York City’s antiquated procurement rules were one of many problems that Schloss inherited as CIO. Perhaps the biggest is compensation. When Schloss joined in January 2010, the Bureau of Asset Management had a staff of 22 people making a combined $2.5 million. Add in Schloss’ $224,000 in annual compensation — what a first-year associate with an MBA makes on Wall Street — and the entire team overseeing New York City’s $120 billion in pension assets is still making less than the $3.5 million that their uptown neighbor Columbia University pays Nirmal Narvekar to manage its $8 billion endowment.
Finding competent and committed investment veterans like Gantz in the public sector is rare. As head of an asset class, he makes $175,000 a year. An entry-level position at the Bureau of Asset Management pays $65,000 to $75,000; senior investment analysts make $80,000 to $85,000; a senior investment officer earns $110,000; and there are no bonuses. To make matters worse, the staff must live in one of New York’s five boroughs, which are expensive.
“It’s tough to hire people when you can’t pay them,” Schloss says.
Then there is the 58-trustee, five-board structure itself. Each of the New York City retirement system’s five boards meets separately twice a month. One of those meetings is to discuss benefits; the other, investments. Assuming a manager is going to be hired to invest money for all five funds — as is often but not always the case, because each fund has its own asset allocation — the manager has to present to and win approval from all five boards. It is anything but a swift process. It also leaves board members open to lobbying by managers.
The system makes terminating managers cumbersome and leads to overdiversification because once managers get on the books they tend to stay there. This is why money managers view pension funds as sticky money. It also explains how New York City’s pension plan ended up with 362 outside managers overseen by ten consultants — and how it ended up paying hundreds of millions of dollars in fees but not always getting much in the way of investment results.
Not long after getting the deputy comptroller job, Schloss started talking with pension officials around the U.S. and in Canada, many of whom he had gotten to know well during his years as a private equity manager. Although the New York City retirement funds have their quirks, he quickly found out that the root problems — poorly compensated staff, a politicized investment process and a bursary that had failed to keep pace with increasingly complex capital markets and a sophisticated investment approach — were anything but unique.
“Some of these problems are the same in every public pension system,” says Schloss. “Understaffed, undercompensated, some degree of RFP process, some degree of lack of delegation from the board.” He believes there has to be a better way to manage public pension money.
IN FEBRUARY 2010, SEEMA HINGORANI was looking for a job when a friend of hers who also knew Larry Schloss suggested that she contact the new deputy comptroller. “I literally just cold-called him at 5:00 on a Friday afternoon,” Hingorani recalls. “I said, ‘I want to come work for you,’ and he said, ‘Really?’ ”
The 43-year-old Hingorani had the right blend of investment management experience, entrepreneurial drive and commitment to public service that could inspire her to want to work for the city retirement system. She had worked in the hedge fund industry and co-founded her own fund, Mirador Capital Management, before taking a break and later helping Hillary Clinton with her 2008 presidential campaign.
A few weeks after Hingorani called Schloss, they met for lunch at City Hall Restaurant, near the comptroller’s office. There was a massive snowstorm that day, and it was a struggle for Hingorani to get into New York from Darien, Connecticut, where she was living at the time.
“I think Larry was surprised that I made it,” she says.
Hingorani and Schloss have a lot in common. A Yale graduate with a BA in psychology and philosophy, Hingorani worked at DLJ (though her path never crossed with Schloss’) before earning her MBA in finance from Wharton. She began her investment career at T. Rowe Price and later worked at hedge fund firms Pequot Capital Management and Andor Capital Management, and at Fidelity Investments’ Pyramis Global Advisors. Schloss and Hingorani hit it off immediately, and Hingorani soon found herself agreeing to take on the job of head of public equities and hedge funds for the Bureau of Asset Management, and to move to New York.
The daughter of Indian immigrants, Hingorani is a big believer in public service. Her father was a civil engineer who, among other accomplishments, helped design the Verrazano-Narrows Bridge connecting Staten Island to Brooklyn and served as a member of the city council in Norwalk. It was the memory of her dad, who had died of pancreatic cancer, and the experience of working with Clinton that inspired her to pursue an opportunity in the public sector.
“My father always believed in public service,” she says. “I watched how hard he worked for people, and that made a great impression on me.”
Since taking over management of the $60 billion equity portfolio, Hingorani and her team have been diversifying and streamlining in an effort to reduce volatility, cut costs and improve returns. One of Hingorani’s first acts was to create what Schloss calls an equities toolbox. The toolbox is made up of a variety of different types of indexes that can be used to house assets when the fund terminates or changes a manager, without affecting the asset allocation. Hingorani and Schloss have terminated 23 of the pension system’s active public equity managers since the spring of 2010.
In the fall of 2010, Schloss initiated an asset allocation study of the entire pension system; it was completed last summer. The resulting new asset allocation reduced equities from 70 percent to 65 percent and increased fixed income from 30 percent to 35 percent. In the equity portfolio the system has shifted from 77 percent in passive index funds to 83 percent. At the same time, it is moving some of its equity allocation into emerging markets and hedge funds.
In April 2011, Schloss hired Barry Miller, previously a partner with New York-based private equity firms Nottingham Capital Management and Pomona Capital, to oversee private equity. That same month Rafique DeCastro joined from Credit Suisse as a private equity investment officer.
Miller, who like Schloss is a graduate of Tulane, says one of the biggest problems with New York City’s private equity portfolio is that it is overly diversified, investing with 110 different general partners and in 175 different funds. “The system is better off building a more concentrated portfolio. We need to reduce the number of relationships,” he says.
Miller has put up for bid $1.8 billion of the system’s legacy $7 billion private equity portfolio, which is considered part of the overall equity allocation. The fund is also moving away from venture capital, which Schloss and Miller believe is not a good fit for large public retirement funds. With venture capital, Miller explains, “a retirement system cannot get into a top quartile or top decile manager, and if they do, the allocations are so small.”
The fixed-income portfolio has been undergoing its own transformation. In early 2011 the New York City retirement system sold a significant amount of its high-yield debt, catching the top of the market and contributing to the strong 2011 fiscal year returns. The shift out of high-yield fixed income, which the pension system is now in the process of reversing, was part of a new focus on using cash that Schloss has introduced to help manage risk and smooth out volatility.
Recently, Gantz has been hiring managers for a new dynamic, opportunistic fixed-income allocation, to better take advantage of the changing markets. The new allocation will give sizable mandates, in the $300 million to $600 million range, to a handful of managers, granting them license to invest in all parts of the credit markets, depending on where they see opportunities and have expertise. The approach is one that some sophisticated pension plans, foundations and endowments are starting to take. “This wouldn’t be happening if Larry wasn’t here,” Gantz says. “Larry came here because he wanted to make a difference.”
Not all of Schloss’ hiring decisions have gone smoothly. In September 2011 he appointed Kevin Davis to head up commodities investing for the Bureau of Asset Management. Davis had been CEO of MF Global for more than a decade before leaving in 2008; Schloss, who had served on the board of the broker-dealer from September 2007 to January 2010, thought he was the best applicant for the job because of his extensive capital markets experience. Davis’s connection with MF Global created a public uproar after the firm filed for bankruptcy on October 31, even though the former CEO had no connection to the recent trading losses. Davis resigned. He worked at the bureau for just nine weeks.
To Teamsters Local 237 president Floyd, the Davis incident is a prime example of Wall Street cronyism. “Larry Schloss came from MF Global, where he was on the board of directors,” Floyd says. “There is a conflict there. And he lured his buddy from MF Global, Kevin Davis, to join him.”
In his efforts to diversify the pension system, Schloss has had an ally in Ranji Nagaswami. Appointed by Bloomberg in April 2010, Nagaswami is the city’s first chief investment adviser. With her 20-year background in investment management, she is Schloss’ equal in terms of institutional investment expertise. As chairwoman of the NYCERS board and an adviser to the mayor’s appointees on the four other pension boards, she has championed the new asset allocation.
I FIRST MET LARRY SCHLOSS EARLY last fall, a few days after the 2011 fiscal year performance numbers had been released. He was on a high from the success and keen to talk about all the changes that had gone into it. We had dinner at Union Square Cafe, splitting the bill as required by the city’s rules and regulations (and to the subsequent horror of my company’s expense department; Danny Meyer’s restaurant isn’t cheap). Though I was impressed by what Schloss and his team had achieved, I remained skeptical. It seemed to me that there was nothing to stop the next comptroller from coming in and undoing all of his, and by extension Liu’s, good work. Although I did not know it then, the comptroller was already way ahead of me.
During his first year on the job, Schloss sought out several pension experts for advice, including Ontario Teachers’ CEO Leech. Though almost identical in size to the New York City retirement system, Ontario Teachers’ has had far better investment performance. It is one of the top pension funds in the world, with average annual returns in excess of 10 percent over the past 20 years.
“People ask me what is the secret of our success,” says Leech, who joined the retirement fund in 2001, becoming president and CEO in 2007. “I start off by saying it’s the governance.”
The Canadian pension fund is structured like a corporation. It has a CEO, who has relative autonomy over the day-to-day operations but reports to a nine-person board made up of appointed representatives from the government and labor. The board in turn is responsible for appointing the CEO, just as it would at a company. Better operational governance, the theory goes, makes better returns possible because it creates a more nimble, efficient organization, where staff can be paid reasonably and incentives are more aligned with the overall goals of the organization — that is, better risk-adjusted returns.
After reviewing other public pension models, Schloss took his findings to the comptroller, who then spoke with Leech and other large pension managers. “The experience we have is drawn from some of the successful funds,” says Liu. “They earn 1 to 2 percentage points higher than our funds. That is $1 billion to $2 billion every year.”
Changing the governance of the New York City pension system requires legislation at the state level. Last summer the comptroller and his staff worked on a proposed reform of the system. They solicited input from the mayor’s office and organized labor. “Labor overwhelmingly recognizes that the next 70 years cannot look like the last 70 years,” says first deputy comptroller Eve.
Weeks of discussions led to a set of proposed governance reforms. The five existing pension fund boards would delegate authority to a single pension investment board. The Bureau of Asset Management would spin out from the comptroller’s office and become an independent investment management company reporting to the new board. The asset management company would adopt best-in-class practices, and the new board, with guidance from the five parent boards, would set the strategic mission and guidance of the five pension funds. The asset management company would have its own CIO, to be appointed by the board, and would be responsible for the consultant and asset management pool. Certain asset classes would be managed internally, and the Procurement Policy Board rules would not apply to the pension investment board or the asset management company.
“I can’t remember the last time I saw an elected official willing to say, ‘In the interests of the greater good, I will cede some of my authority,’ ” says Eve, who served as a special assistant for political affairs to former president Clinton. “It just does not happen.”
Yet that is exactly what Liu is proposing.
On October 27, 2011, an extremely unusual press conference was held at City Hall to announce the new proposal. It brought together the mayor, comptroller and trustees representing the pension boards of the firefighters, police, teachers and other public workers.
Transport Workers attorney Cary, however, is skeptical that what he calls the Ontario model is suitable for New York. “I’m not an expert on Canadian society, but for America it is not justifiable,” he says. Different norms work in different countries: “In England people don’t carry guns,” he explains. “In New York everybody has a gun, and nobody trusts Wall Street.”
For Teamsters Local 237 president Floyd, Liu’s willingness to give up oversight of the pension fund is not a sign of political generosity but is happening because the comptroller didn’t want the job in the first place. “John Liu never wanted to be comptroller; he wanted to be mayor or public advocate,” Floyd says. “He sees the job of comptroller as beneath him.” The teamster adds that the responsibilities of the comptroller’s office are “not John Liu’s to give away.”
When I raised with Liu the question of whether his political ambition had motivated the proposed changes to the pension system, he waved it away. “Every action that I have taken in this office has been the subject of that observation,” he told me. “What we have proposed is a broad-reaching reform.”
After that meeting with Liu in late December, I walked across the street to City Hall to meet with deputy mayor Bob Steel. A former vice chairman of Goldman Sachs who briefly served as CEO of Wells Fargo & Co., and a former undersecretary for domestic finance in the Treasury Department, Steel comes with impressive policy credentials. Since Steel’s arrival in the Bloomberg administration in June 2010, his position on the pension issue has been clear and unwavering: Yes, investment reform is needed, but the real issue is the size of pension liabilities — and to fix that, benefit reform will be required.
“It is an asset and liability issue,” Steel told me. He used the analogy of someone who has been ill. “We don’t believe that if you start eating right that you’ve completely solved the problem,” he explained. “You also have to exercise and take your medication.” As part of that medication, Bloomberg has been supportive of Cuomo’s push to add a defined contribution option for public workers.
Even among the labor unions that have agreed to the reforms, much remains to be worked out. There is, for example, very little agreement about who would serve on the new pension board and what the exact makeup of such a board would be. One sticking point for labor is how much financial experience would be needed for someone to qualify as a board member. The unions typically do not have members with a lot of investment knowledge.
To Cary the proposed reforms are the equivalent of the unions putting their assets into a blind trust. “The only person working in the public sector that I know of who puts his money into a blind trust is the president of the United States,” he says. “And he gets to be president!”
The Transport Workers are not insensitive to some of the issues. Cary points out that they have agreed to all the proposed investment changes. They also agree that there should be a way to pay Bureau of Asset Management employees more-competitive wages. (“I think Larry is severely underpaid,” Cary said of Schloss during the November NYCERS investment meeting.) But none of these problems, to Cary’s mind or to the minds of his clients, requires the type of wholesale structural changes the comptroller is proposing.
The comptroller’s office has to keep its reform coalition together and win support in Albany. When I spoke with Eve in late November, he acknowledged the challenges, as well as the goodwill, among the parties involved but said the intent was to have legislation by this fall. “The goal here is to approach Albany with labor, the mayor, the comptroller and the business community all on the same page,” he said, adding, “That rarely happens” in politics. And if it happens, he said, “we will have a very strong coalition.”
In late January a coalition of trustees calling themselves the New York City Police-Fire Superior Officers Alliance proposed an alternative solution. They suggested keeping the current structure — with five boards and the comptroller managing the pension funds — but would make the process more efficient by having the boards meet together instead of separately.
Floyd, for one, does not give Liu great odds of getting his legislation through Albany. “I think it is going to come to nothing,” the Teamsters local president says.
He is also no fan of Schloss. Since joining the system, Floyd says, “Larry Schloss has done nothing but skirt procurement rules and board process and push trustees out of the process.” As to the new CIO’s motivation, Floyd hazards it is “to feather his own nest so when he gets back to Wall Street he is owed favors.”
Who can blame Schloss for seeking to focus on investments? New York City politics takes no prisoners. There is a certain irony in the fact that during his time on Wall Street, Schloss had little reason to deal with politics. DLJ in particular was a remarkably nonpolitical organization. Now Schloss is getting schooled by some of the most sophisticated political players in the U.S. At stake: the futures of New York City’s firefighters, police, teachers and other public workers. • •