Life's a peach

Keep it simple.

That's the motto of the $42.4 billion Teachers Retirement System of Georgia and the $12.4 billion Employees' Retirement System of Georgia, and it doesn't get much simpler than their current asset allocation: U.S stocks and a smattering of foreign equities; U.S. Treasuries and a few investment-grade bonds; cash. Strictly verboten: foreign and high-yield bonds, distressed debt, real estate, private equity and anything resembling a hedge fund.

The approach could not be more basic or more old-fashioned or, for the past few years anyway, more right. The two plans are among only a handful of state retirement systems that are overfunded, the value of their assets exceeding the value of their liabilities. As of June 30, 2003, the most recent data available, Georgia Teachers had a funding ratio of 101.1 percent; the Employees' plan was 100.5 percent funded. The median funding ratio for state plans at the end of 2003 was 79 percent, according to consulting firm Wilshire Associates.

"Our approach is one of conservatism and gradualism that has been applied consistently over a very long period of time," says Charles (Bill) Cary Jr., who heads the Division of Investment Services along with co­chief investment officer Nancie Boedy. The division, headquartered in a low-rise, 1960s-vintage steel-and-glass building in northwest Atlanta, manages the assets of the plans, which cover 207,000 teachers and 74,000 state workers. DIS reports to W. Daniel Ebersole, the state treasurer and chairman of the investment committees of the boards of both plans. Any significant changes in investment policy or strategy must be approved by the plans' boards of trustees.

Why are the Georgia plans overfunded when so many public retirement systems are grappling with swollen deficits? Credit conservative asset allocation and actuarial assumptions, strict fiscal controls, tough vesting rules and a statutory requirement that any increase in retiree benefits be immediately funded when it was authorized by the state legislature.

In its quintessentially conservative asset allocation, the teachers' plan keeps 47 percent of assets in U.S. and Canadian equities; 4.8 percent in foreign equities; 40.2 percent in U.S. Treasuries; 6 percent in investment-grade bonds and 2 percent in cash. (The Employees' plan follows a very similar asset allocation.) For its fiscal year ended June 30, 2003, Georgia Teachers returned 4.6 percent, compared with 4 percent for the median public plan, according to Wilshire Associates' Trust Universe Comparison Service survey. Over three years the Georgia plans returned ­1.6 percent, despite a $129 million loss on their Enron Corp. stake, versus the TUCS median of ­2.3 percent. But over five years, which include the final year of the bull market, Georgia's cautious approach caused it to underperform, returning an average annual 2.6 percent, versus the 3 percent median.

State law mandates the funds' strict fiscal controls. The Public Retirement Systems Standards Law enacted in 1983 requires that the state legislature appropriate funds to pay for any retiree benefit hike at the same time that an increase is authorized. Few states have such strictures in place. In addition, the plans make quite conservative actuarial assumptions. Because they assume a lower rate of return on assets -- the current assumption is 7 percent a year for the employees' plan and 7.25 percent for the teachers' fund, versus 8 percent for most public plans -- the state government has to make greater contributions to the plan than it otherwise would.

Last, although Georgia pays retiree benefits that are slightly above the median for state plans, its vesting rules are considerably less generous. Both plans require ten years of service, twice the industry norm, before workers are fully vested and thus eligible to receive their employer's contribution to the plan.

"We've always taken a conservative fiscal approach," says state auditor Russell Hinton, a member of the investment committees of the boards of both plans. "We've stayed away from accounting gimmicks and raids on our pension funds."

"It's admirable that Georgia has a process in place that controls the degree to which funding can deteriorate," says Robin Pellish, CEO of Greenwich, Connecticut­based Rocaton Investment Advisors, a leading pension consulting firm. "At a time when markets were underperforming, this process led the legislature [during the three fiscal years ended June 30, 2003] to put enough assets in the fund to meet their ongoing liabilities."

Beneficiaries appreciate the plans' funding status. "It means my welfare and benefits are secure, and I don't have any apprehensions about my benefits for as long as I live," says Burney Lester, 72, a Macon, Georgia, retiree who taught high school science and worked as a junior high school principal.

Less admirable to some was the role played by the General Assembly back in 2000 when it passed a law authorizing the Legislative Retirement System's board, which also oversees the Employees Retirement System, to increase retirement benefits for state legislators (see box).

Unquestionably, though, fiscal prudence helped the state plans weather the perfect storm that struck pension funds from 2000 through 2002. During this period a disastrous combination of declining stock prices, which depressed the value of plan assets, and falling interest rates, which increased the present value of future liabilities, left many public plans under water. Although 2003's strong equity markets were a positive -- median public plan assets grew 22.7 percent -- falling interest rates meant that liabilities continued to grow.

While Georgia's funding constraints and asset allocation are unusual, in other respects its pension funds are well within industry norms. Nearly 75 percent of fund assets are managed in-house. All of the internally managed equity assets are in index or enhanced index funds; all the fixed-income portfolios are actively managed.

The remaining 25 percent of fund assets, all in equity, are handled by 11 outside money managers, including Banc of America Capital Management, Evergreen Investments, NCM Capital Management Group, State Street Global Advisors and seven small Georgia firms. As a group the 11 managers posted an average annual return of ­11.9 percent for the three years ended June 30, 2003, slightly worse than the 11.2 percent decline for the Standard & Poor's 500 index.

Fiscal 2004 results won't be reported until next July, but no abrupt moves are expected. "Our investment strategy is evolutionary," says Ebersole. "We don't make sudden changes."

IF THE MANAGEMENT OF GEORGIA'S PENSION funds seems a throwback to a simpler time, so too do the careers of chief investment officer Cary and co­chief investment officer Boedy. Both arrived at the Division of Investment Services in the 1970s and have worked there ever since.

Born and raised in Atlanta, Cary earned his BA from the Georgia Institute of Technology and his MBA from Georgia State University. He joined the DIS in 1972 as a security analyst and was named assistant director in 1976. In 1988 he became CIO.

Boedy, a Chicago native, earned her BA from Northwestern University. After working for a few years as a research analyst at several Atlanta brokerages, she joined the DIS in 1977 as a senior security analyst. Several years later she won a promotion to portfolio officer and in 1988 signed on as co­chief investment officer.

Until the early 1970s, Georgia Teachers, which was established in 1943, and the state employees' plan, set up six years later, invested mainly in fixed income. In 1972 the state legislature passed a law allowing the pension funds to invest up to 50 percent of plan assets in equities. The limit rose to 60 percent in July 2000. That was fortuitous, of course, because it meant that the Georgia funds were constrained from loading up on stocks until after the Nasdaq cracked.

It was also in 1972 that the state government set up the DIS to manage plan assets. Through the decades the division and the plans' trustees have worked closely together. By all accounts it has been a harmonious relationship. "When we decide to change allocation targets," Boedy reports, "we forge a consensus between the board and the DIS staff."

At key junctures, though, the spark for changes in investment strategy has come from the state legislature, not the DIS. In 1995, for example, the retirement committees of the state senate and house introduced legislation to permit the funds to invest up to 5 percent of plan assets in foreign stocks and bonds. In 2000 the cap was raised to 10 percent.

The plans' above-average allocation to fixed income bolstered performance during the tough 2000­'02 period. For the three fiscal years ended June 30, 2003, Georgia's Treasury-heavy fixed-income portfolios returned an average annual 11.3 percent, versus 10.8 percent for the Lehman Brothers aggregate bond index.

On the other hand, Georgia's equity portfolios have underperformed some benchmarks. For the fiscal year ended June 2003, they returned ­2.1 percent, versus ­1.5 percent for the S&P 500.

Thanks to its approach, Georgia, unlike many states and municipalities, has not been forced to issue pension obligation bonds to prop up underfunded pension plans. And while the median state plan funding ratio dropped from 115 percent in 2000 to 79 percent in 2003, the Georgia plans' funding ratios held between 100 percent and 104 percent during the same period. According to consulting firm Wilshire Associates, several other plans, including the Regents of the University of California, the New Jersey State Police Retirement System and the North Carolina Public Employee Retirement System, were overfunded as of June 30, 2003. But they report actuarial data a year or more late, as does Georgia.

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The Georgia plans do not track what percentage of the workforce fails to become vested, but the rules clearly give Georgia a comparative funding advantage over state pension funds that vest their employees after five years. Twenty years ago, explains Nancy McKenzie, the pension specialist at the National Education Association, most teachers' retirement systems had ten-year vesting. But after Congress in the 1980s required corporate funds to move to five-year vesting, many teachers' plans began to make a similar move. "Plans with ten-year vesting have become the minority," says McKenzie.

If Georgia's five- to ten-year teaching veterans had been eligible for retirement benefits and their payments had been included in the overall average, it would, all other things being equal, have brought down Georgia's current average monthly benefit payment of $2,072.

Says Ron Gebhardtsbauer, senior pension fellow at the American Academy of Actuaries, "It depends heavily on the variables -- how long employees stay, what they earn and so on -- but including five- to ten-year workers could have a fairly significant impact on the average benefit." Certainly, the tough vesting rules help support the plans' strong funding status, and that in turn has strengthened the state's fiscal position, helping Georgia to sustain an AAA rating from S&P on its general obligation bonds. Only nine states currently earn triple-A status from S&P.

But the state's finances face other threats. At the moment, Georgia's budget is balanced with virtually no room to spare. If the state faced a budget crisis, it might be hard-pressed to make full contributions to the pension funds.

The 2000­'01 recession and subsequent anemic recovery in the critical Atlanta region -- driven by weakness in telecommunications and tourism -- have taken a toll. The administration of Republican Governor Sonny Perdue estimates that Georgia's surplus for fiscal 2005, which ends June 30, will total just $145 million, or 1 percent of the 2004 budget of $14.5 billion.

"The state's 2004 budget projections turned out to be ambitious," says S&P analyst Ken Gear. But for fiscal 2005, he notes, the government set reasonable targets and is controlling spending. It's taking a conservative approach.

So, too, are Cary and Boedy in managing the Georgia pension funds. While other pension officers cast about for new hedge fund managers and design elaborate asset allocation strategies, the Georgia folk are sticking to their stocks and bonds. Their investment approach is as simple as it gets. But when it's combined with fiscal controls and conservative accounting, the results are impressive indeed.