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It isn't easy to grapple with shaky funding ratios and onerous spending demands as market returns soften, yet some fund managers do an impressive job of beating the odds.
But observers -- not least the company's 49,000 workers in the U.S.-- were less than reassured when Miller told a Financial Times reporter that he feared "intergenerational warfare" as younger workers were balking at funding the retirements of their elders. The fate of Delphi's $4.5 billion pension plan, which is, incredibly, $4.3 billion underfunded, as well as the retirement security of its workers, is very much up in the air.
The Delphi filing -- and its CEO's intemperate rhetoric -- offered a reminder, if one was needed, of the critical mission of the company pension plan. Now more than ever, U.S. corporate and public pension funds find themselves in parlous straits. In corporate boardrooms, city halls and state capitols, pension managers are grappling with shaky funding ratios even as they anticipate only modest asset appreciation in coming years.
Yet an elite group of pension managers are running their funds with imagination, sophistication and verve. They're overhauling asset allocation, refining spending policies and, always, carefully monitoring risk. And in safeguarding the retirements of millions of American workers, these pension fund executives perform a vital service. Their counterparts at foundations and endowments serve a no-less-critical role, financing higher education and supporting a vast range of cultural, social and scientific activities conducted by thousands of nonprofits, from local dance troupes to world-class teaching hospitals.
To recognize the accomplishments of outstanding pension, foundation and endowment managers, Institutional Investor last month announced, at a gala dinner at New York's Metropolitan Club, its second annual awards for excellence in investment management. In selecting the four winners and 13 finalists, the editors weighed, among other factors, nominees' innovativeness and their records of achievement in investment performance, asset allocation, liability management and risk control.
Our 2005 winners: Donald Foley, senior vice president, treasurer and director of taxes, ITT Industries; Peter Gilbert, chief investment officer, Pennsylvania State Employees' Retirement System; Laurance (Laurie) Hoagland Jr., CIO, William and Flora Hewlett Foundation; Jack Meyer, president and CEO, Harvard Management Co.
Last year's winners: Gary Findlay, executive director, Missouri State Employees' Retirement System; William Quinn, president, American Beacon Advisors; Linda Strumpf, CIO, Ford Foundation; and David Swensen, CIO, Yale University.
It's a difficult environment for even the most dexterous manager. True, funding may be be a little less wobbly today. Ratios for corporations have increased -- an average of 90.5 percent for the 100 largest U.S. corporate plans at the end of 2004, up from 88.8 percent a year earlier, according to consulting firm Milliman USA; for state plans, they were up to 83 percent at the end of 2004, from 77 percent at the end of 2003, according to consulting firm Wilshire Associates.
But the ratios are still far from their bull market highs of 130 percent for corporations and 112 percent for public plans. More important, they remain below the 95 percent ratio that experts say pension plans require to be on sound financial footing.
Moreover, pension fund managers face uncertain contributions from employers; they must ensure future payment of obligations that can be estimated but never known; often, too, their boards have imposed constraints on their investment strategies.
Institutions that rely on public largesse -- and their own internal resources -- face their own challenges. Foundations typically disburse 5 percent of their total assets each year, which means that they must at least meet that performance hurdle, plus inflation, if they are to maintain real spending on programs over the long haul. Nonprofits unable to draw on federal funding increasingly rely on foundations to provide them with critical financial support.
Colleges and universities have also become more reliant on investment returns as they have sought to broaden their capital bases and provide adequate resources to support their operating budgets.
In that context, Massachusetts Institute of Technology treasurer and CIO Allan Bufferd, an award finalist, points with pride to his institution's much-improved funding ratio. This critical gauge of the endowment's financial health measures the ratio of total investments to MIT's operating expenses. For the fiscal year ended June 30, 2005, MIT's ratio stood at 3.9-to-1, up from 1.6-to-1 in fiscal year 1990.
Over the past 15 years, Bufferd notes, MIT's investments have helped fund major capital renovations, graduate student fellowships and faculty chairs as well as the considerable expense of need-blind admissions. Says Bufferd, "A world-class university must have the financial resources necessary to provide new and expanded facilities and to respond to opportunities in science and technology."
As our finalists and winners make clear, there are different paths to investment excellence. A range of asset allocation and investment strategies can produce first-rate performance.
As it happens, our four winners all make significant bets on hedge funds: Foley's pension plan at ITT invests 12 percent of its assets in hedge funds; Hoagland keeps 20 percent of the Hewlett Foundation in the asset class; Gilbert keeps 22 percent of Pennsylvania's assets in funds of hedge funds, using a portable alpha strategy.
HMC had a 12 percent allocation to absolute-return funds as of June 30, but the percentage tells only part of the story: Until he stepped down at the end of September, CEO Meyer ran HMC as though it were a hedge fund. Back in the spring of 2005, the impresario investor described the challenges of delivering alpha in a market crowded with hedge fund competitors. "All of those yummy, easy trades that we could do in the 1990s -- they're all gone," Meyer said. "So yes, it's going to be more difficult."
Managers who avoid hedge funds often keep a stake in other alternative assets. At the Oregon Public Employees Retirement System, investments director Ronald Schmitz, a finalist, holds 8.6 percent of plan assets in alternatives, mostly in buyout funds and distressed debt. The San Francisco Employees' Retirement System shuns hedge funds, but executive director Clare Murphy, another finalist, keeps 10.3 percent of assets in venture capital, private equity and distressed debt.
The 17 managers honored by II are all at the top of their game. But along with their peers, they confront a basic challenge: Market returns are likely to be modest in coming years, while spending pressures will be acute.
For that reason, observers wonder if pension plans have any realistic hope of reaching full funding status in the near future. Notes Gabriella Barschdorff, vice president at J.P. Morgan Asset Management's strategic investment advisory group: "Under average assumptions, we find that organic growth for pension liabilities will be about 8 percent. So to stay even, your assets need to grow by 8 percent as well." But if you start out from an underfunded position, she adds, "you'll need something north of that to improve your funded status." She estimates that the median plan will need to grow its assets 10 to 11 percent every year for ten years to reach full funding.
"We project that stocks will average a return of about 7 percent for the next ten or 15 years, and aggregate bond returns will be about 5 percent," Barschdorff says. "Reaching full funding is going to be a real challenge." But some pension managers, like our honorees, ought to be up to the task.
HOAGLAND: Mixing it up
Over the course of a 42-year career in finance, Laurance (Laurie) Hoagland Jr. has earned a reputation for intellectual generosity that matches his renown for investing acumen. In 1991, Hoagland -- now chief investment officer of the William and Flora Hewlett Foundation -- set aside a lucrative career as co-founder of Anderson, Hoagland & Co., a St. Louisbased investment management firm, to take charge of Stanford University's then$1.87 billion endowment. The lanky, debonair investment manager was the first CEO of the newly created Stanford Management Co.
During his nine-year tenure at Stanford, his alma mater, Hoagland shepherded the university's portfolio to an average annualized return of 18.4 percent; by the time he left in August 2000, at the end of the fiscal year, the endowment totaled $8.58 billion. Hoagland took charge of the Hewlett Foundation's assets in January 2001. From the moment he arrived, he began to methodically overhaul the organization's portfolio, which was heavily invested in shares of Hewlett-Packard Co. and spin-off Agilent Technologies. He transformed a single-asset portfolio into a multiasset portfolio without breaking stride.
"Any foundation that remains a single-stock foundation is likely at some time to pay a very, very high price," says Hoagland, 68. After graduating from Stanford he attended Oxford University on a prestigious Marshall scholarship, receiving his master's degree in philosophy, politics and economics. He also has an MBA from Harvard Business School. "My main objective was to get the diversification done and get the risks off the table," he says.
Over the past four years, Hoagland has done just that, moving aggressively into international markets, reducing U.S. equity exposure from 50 percent of the portfolio to 21 percent and building up a 20 percent allocation to hedge funds. An avid traveler, he has also sought out unusual direct investments in private equity and real estate funds throughout Europe and Asia. (Before joining Hewlett he spent four months exploring Iran, Peru, Tunisia and Uzbekistan, among other countries.) Under his leadership, Hewlett's endowment returned 15.4 percent in 2004, compared with an average of 11.4 percent for foundations with more than $1 billion, according to a Commonfund survey. Hewlett has been in the top quartile of U.S. foundations for one-, three- and ten-year periods.
Hewlett now ranks as the seventh-largest foundation in the U.S., with nearly $6.9 billion under management. Beyond the 20 percent dedicated to absolute-return strategies, which are market-neutral, Hoagland uses swaps and derivatives -- which do not require significant cash outlays -- to overlay all or part of the absolute-return portfolio with U.S. stock or bond exposure. As much as he appreciates hedge funds, he's not inclined to miss out on market, or beta, returns.
"I'm greedy," Hoagland says with a laugh, "because I like absolute return as a way to generate alpha, but I don't want to give up the beta. So we try and roll it all up into one neat package." -- Loch Adamson
FOLEY: Man of action
Who needs indexers? Donald Foley has invested ITT Industries' $4.5 billion in pension assets entirely with active managers.
"We don't have a fear of doing things that are out of the ordinary," says Foley, 54, ITT's senior vice president, treasurer and tax director. "We're getting a lot more value than could be gained through passive strategies."
For the fiscal year ended September 30, ITT's plan returned 21 percent. Over three years it returned an average annualized 19.7 percent; over five years 6.4 percent. For the year ended December 31, 2004, the plan returned 16.3 percent, handily beating the 12.2 percent average for the 100 biggest corporate plans, according to consulting firm Milliman USA. Over the three years ended December 2004, ITT's plan returned 10 percent, versus a 7 percent average.
Although many pension funds have been boosting their real estate stakes, ITT has no presence in the asset class and hasn't since 2000. Foley sees real estate "as a proxy for fixed income, but with a lot less liquidity." He prefers to put the money into high-yield bonds or private equity instead, he says. ITT also has bet heavily on alternatives: 12 percent of the portfolio is in hedge funds, 8 percent in private equity. Foley's biggest pile of chips is on U.S. equities, which make up 48 percent of the portfolio; 16 percent is allocated to international stocks and an equal amount to bonds.
Foley joined ITT as vice president and treasurer in 1996 and rose to his current position in February 2003. Before ITT he worked at International Paper Co. as assistant treasurer; earlier he was in finance at General Electric Co. and Mobil Corp. He earned his MBA in finance from New York University in 1980.
"I've had a good deal of experience and a good deal of academic knowledge, all of which has lent me a sense of confidence," says Foley. "But it's not cockiness or overconfidence." -- Steven Brull
Peter Gilbert's cool demeanor is deceiving. The CIO of the $27 billion Pennsylvania State Employees' Retirement System has a competitive drive that has pushed him to excel at triathlons. His investment performance is no less impressive: For the year ended June 30, Pennsylvania's fund returned 13.5 percent, placing it in the top decile among large public pension plans, according to Wilshire Associates. Over the past ten years, it has returned an average annualized 10.1 percent, for a top-quartile ranking.
Gilbert's portfolio has more in common with a sophisticated endowment or foundation than with the typically staid public pension plan. After joining the retirement system in 1993, Gilbert realized that the demographics of Pennsylvania's plan were quite mature; it had a negative cash flow similar to that of a foundation that has to pay out 5 percent of its assets annually. "It seemed to make sense that their asset allocations served as a better model than traditional state pension plans, which at the time were much younger and had very positive cash flows," says Gilbert, 58.
Today the fund invests 34 percent of its assets in U.S. equities, 22 percent in foreign equities, 16 percent in fixed income, 8 percent in inflation-hedging assets such as commodities, 7 percent in real estate and 12 percent in alternatives, including venture capital, buyouts and distressed debt; the rest is in cash. That's not so unusual. But included in the U.S. equity portfolio are 22 percent of total fund assets invested in hedge funds as part of a portable alpha strategy; the returns are overlaid; beta is acquired through swaps and futures. An additional 3 percent of assets will be invested in hedge funds early next year, with returns linked to small- and midcap equity allocations. Derivatives are used to create a position equal to about 5 percent of fund assets in the Goldman Sachs commodity index; the cash that's freed up is invested in intermediate Treasury inflation-protected securities.
After earning a BA from Wesleyan University in 1969 and a master's in science management from Columbia University in 1976, Gilbert worked as an executive in nonprofit and governmental mental health agencies before joining New York City's Comptroller's Office as a research director in 1980. He rose through the ranks and served as the comptroller's representative to the city's pension board of trustees. "That gave me access to some of the best and most brilliant minds in the investment world," he recalls. Among them: Jack Meyer, who recently resigned as president and CEO of Harvard Management Co. (see page 68), and Marvin Damsma, the widely admired director of trust investments at BP America. Before Gilbert joined the Pennsylvania system in Harrisburg, he spent three years as director of New York City's pension unit, overseeing assets of more than $46 billion.
"The greatest thing about this business is that it's a constant intellectual challenge," he says.
Gilbert likes physical challenges as well: He began competing in triathlons when he turned 50. In July he and his wife, Linda, competed in an iron-man competition in Lake Placid, New York. Both finished third in their age group in the race, which required them to swim 2.4 miles, bike 112 miles and run 26.2 miles. "Every time I do it, I'm amazed," Gilbert says. "It's like a leap of faith." -- S.B.
THE HEAD OF THE CLASS
Here are the winners and finalists in Institutional Investor's second annual awards for excellence in investment management.
Laurance (Laurie) Hoagland Jr., chief investment officer, William and Flora Hewlett Foundation
Stephanie Lynch, chief investment officer, Duke Endowment
William Petersen, chief investment officer, Alfred P. Sloan Foundation
D. Ellen Shuman, chief investment officer, Carnegie Corp. of New York
Corporate pension funds
Donald Foley, senior vice president, treasurer and director of taxes, ITT Industries
Sheila Berube, finance manager, treasury division, 3M Corp.
Lisa Hillman, manager of investments, United Parcel Service of America
Salim Shariff, managing director and chief investment officer; Richard Taggart, chief financial officer and chairman of the investment committee, Weyerhaeuser Co.
Public pension funds
Peter Gilbert, chief investment officer, Pennsylvania State Employees' Retirement System
Robert Maynard, chief investment officer, Public Employee Retirement System of Idaho
Clare Murphy, executive director, San Francisco Employees' Retirement System
Ronald Schmitz, director of investments, Oregon Public Employees Retirement System
Jack Meyer, president and chief executive officer, Harvard Management Co.
Allan Bufferd, chief investment officer and treasurer, Massachusetts Institute of Technology
Andrew Golden, president, Princeton University Investment Co.
Michael McCaffery, president and chief executive officer, Stanford Management Co.
MEYER: Crimson and over
Jack Meyer just can't stop investing money for Harvard University. The legendary president and CEO of Harvard Management Co., who stepped down at the end of September, is still overseeing Harvard's fixed-income portfolios as a subadviser; he will continue to manage a sizable allocation from the school's endowment in his new role as co-founder and CEO of fixed-income investment firm Convexity Capital Management, which is expected to launch its first hedge fund in February.
Meyer, 60, will likely have his pick of investors. In the fiscal year ended June 30, the Harvard portfolio generated a return of 19.2 percent, taking the endowment to $25.9 billion. Under Meyer's leadership, the endowment has posted a stunning average annualized return of 16.1 percent over the past ten years, compared with a median return of 9.4 percent for large ($1 billion-plus) funds, as measured by consulting firm Wilshire Associates' Trust Universe Comparison Service. From Meyer's arrival at HMC in 1990 through 2005, Harvard's endowment assets essentially quintupled in size.
"I can't think of any other place where you can bring so many resources to bear in adding value across the full range of asset classes," Meyer says. "Harvard Management Co. was just a spectacular opportunity, and the staff is first-rate. In my next life I will have to be much more focused."
His replacement as HMC president and CEO, Mohamed el-Erian, will join the firm in early 2006 after wrapping up his job as head of emerging markets for bond giant Pacific Investment Management Co. "He's smart, open, energetic, modest and realistic," Meyer says of el-Erian. "I think Harvard has a winner."
Meyer arrived at HMC having already carved out a sterling reputation as chief investment officer of the Rockefeller Foundation, which then had about $2 billion in assets. He had also served as the deputy comptroller for New York City, helping to manage pension and treasury funds that totaled about $20 billion in assets.
The Harvard MBA (class of 1969) has probably done more to ensure the university's health, wealth and academic prowess than any other alumnus in the history of the school. But Meyer was routinely pilloried by some in the university community for defending his portfolio managers' lavish compensation packages. Such scrutiny eventually led to an exodus of talent, including such renowned investors as Jonathon Jacobson, now of Highfields Capital Management, and Jeff Larson of Sowood Capital Management. But his pride in his managers' success has long been tempered by a sense of loss.
"It was not my idea to bring them in and then watch them leave," Meyer says. "So it's been sad from a professional perspective -- and a personal perspective too, because they are all fine people and I've missed them."
Now it's Meyer's turn to be missed. -- L.A.