Abandoning the Pension Rat Race

A sleepy San Francisco Bay Area retirement system was doing everything right when it decided to do everything different.

The organization was performing near the top of its peer group — and continues to. “Investment performance is not the end goal; it’s a measure of progress to meeting our ultimate objective: CCCERA’s future liabilities,” says Timothy Price, CIO of the $7.7 billion Contra Costa County Employees’ Retirement Association. “But to be able to step away from that as a sole measure — it took a lot of courage.” Price joined the public fund in 2012 as a known quantity: He had been one of its lead consultants, advising on CCCERA’s fairly traditional portfolio for actuarial consulting firm Milliman.

For two years Price, 39, kept his head down and returns up, serving with analyst Chih-chi Chu as the investment team responsible for nearly $6 billion, he recounts, seated in the roomy investment office suite, in a low-slung ’70s building in concord, California. Price asked the board for another set of hands. His former Milliman colleague and CCCERA consultant Jeffrey Youngman joined in June 2014.

That’s when everything changed.

Milliman’s lead consultant for the Contra Costa account was set to retire, and Price and Youngman began searching for a replacement. “Given Jeff ’s and my backgrounds, as you can imagine the consultant search was an intriguing project,” says Price. What they and the CCCERA board found with Verus (née Wurts & Associates) laid the bricks for a radically new philosophy — one impossible without an open- minded board and consultant willing to be more than mean-variance-optimizing sycophants. One critical measure Verus took was an enterprise risk tolerance survey to gauge the board’s priorities.

Paying pensions in the short to medium term turned out to be a major area of board focus, and one the investment staff of an 82 percent funded plan might take as a given. Furthermore, according to the survey, “the board was open to illiquidity in a significant portion of the portfolio when and if cash flow needs are met with a high degree of confidence,” as Price described in an email. And thus a top-decile plan began evolving to answer the question, What does a pension fund do?

A pension fund does three things, according to Price, Youngman, Verus, and the CCCERA board: It pays current benefits, grows assets for future benefit payments, and weathers markets to ensure the delivery of the first two.

For each function — liquidity, growth, and hedging — the investment team modeled a dedicated portfolio, so the assets overall no longer needed to serve three functional masters. As they built this new model, Youngman says, “we were looking at our actuarial projections, and saw that our annual benefits payments would soon exceed our contributions in a material way, which is something a lot of plans are facing right now.” CCCERA’s board members bought into the proposed model in late 2015 — a leap of educated faith from the status quo.

The liquidity portfolio came first, tasked with the ability to pay up to four years of benefits at near-zero volatility. Given that mandate, Price says, “all other aspects of the program flowed from that decision.” roughly a quarter of plan assets now reside there (targeted $1.9 billion). CCCERA brought on a trio of fixed-income specialists to stock and run the pool, led by the corporate pension gurus at U.K.-based Insight Investment. The custom portfolio is built to kick off contractual cash flows from interest payments on short-duration high-quality bonds, including corporate credit, and asset-backed structured credit, such as consumer debt and prime auto loan products. “To meet future benefit payments there’s virtually no reliance on sales of securities,” explains Gerry Berrigan, Insight’s head of U.S. fixed income. “It’s insulated both from liquidity challenges and mark-to-market volatility.” such a corporate-paper-heavy portfolio is “very much about rigorous credit research,” adds Victoria May, a leader in Insight’s North America institutional practice.

About 10,000 Contra Costa County plan members received their most recent monthly checks cut straight from the cash flow of CCCERA’s new liquidity pool. A further $5.4 billion (63 percent) is targeted for the future to meet the pensions current workers will one day draw upon. and that leaves price and company solving for the last $900 million or so diversifying portfolio. The CIO ticks off the goals of that program: “A: low to negative correlation to the broad equity markets. B: extremely high liquidity during periods of equity market stress. C: positive carry during ‘normal’ periods.” Easy, right? “If we could find a single asset class that delivers all three of those, that would be perfect,” price says. “If it exists, we haven’t found it yet.” He cracks a smile.

A philosophical thread through this entire exercise has been the recognition of return metrics as proxies for an institution’s goals, not the sole mission. That comes with the potential for ranking lower among peers on absolute return, as others optimize for that goal alone. But at CCCERA, the mission is simple: Do what a pension fund does, and pay its pensions.