As a 15-year-old growing up in Du Quoin, Illinois, a town of 6,600 nestled between the Mississippi and Ohio Rivers, an impressionable William Atwood sent a letter to Democratic presidential candidate Jimmy Carter, wishing him luck in the 1976 election. “I think you will make a great president,” the teenager wrote, not long after the New Hampshire primary. That took some moxie -- everyone in the extended Atwood clan was a stalwart Republican. As it happened, Carter’s campaign staffers in Plains, Georgia, appreciated the letter and later sent an invitation to young Bill to attend the inauguration. Though his parents decided he should stay home, the Du Quoin Evening Call ran a large photo of Bill holding his framed invitation.
“I was just trying to be a good citizen,” Atwood says. “It was pretty incredible how it all happened.”
No longer a starry-eyed teenager, and a registered Republican for the past 24 years, Atwood still likes to defy expectations, and that’s exactly what he has been doing as the new executive director of the Illinois State Board of Investment, the $10.4 billion retirement system for 150,000 current and retired state employees, judges and assembly members. Atwood took the reins of ISBI in March 2003 with no MBA, no CFA and no experience as either a plan sponsor or portfolio manager, fresh from having spent nine years marketing asset managers to Taft-Hartley plans. Not a few observers doubted that he was up to the job, which was plainly one of the toughest pension assignments in the country. With assets at the time of just $8.5 billion and liabilities of about $15.5 billion -- a funding ratio of 55 percent, versus a public plan median of 82 percent -- the pension fund was reeling. ISBI suffered from inadequate resources (it had never employed a consultant), poor investment performance -- a 2002 loss of 11.3 percent, compared with a peer median loss of 8.7 percent -- and state neglect. During the 1980s the state legislature had repeatedly refrained from adequately contributing to its weakling retirement plans, a decision that came back to haunt ISBI in the 1990s when increased contributions proved to be too little, too late.
“The plan stood to benefit from a fresh perspective,” says Atwood diplomatically.
Stepping into a political cauldron, ISBI’s new chief needed all his diplomatic wiles. The water began to boil in May 2003, when the legislature moved to shore up the three faltering state retirement plans: the $32 billion Teachers’ Retirement System of the State of Illinois, the $12.5 billion State Universities Retirement System of Illinois and ISBI. Politicians voted to issue a $10 billion bond, of which $7.7 billion would be poured into the three plans, with ISBI getting $1.5 billion. How to invest the much-needed money became the subject of intense public debate. Concerned about market uncertainty soon after the start of the Iraq War, Governor Rod Blagojevich, a Democrat, thought the pension plans should move cautiously. He pressured them to place the money in ultraconservative investments for up to eight months.
Then, several months after the legislature’s vote, the state senate held a series of public hearings to debate whether the retirement plans should be required to increase the number of small money managers and minority-owned firms on their payrolls.
“Healthy debate and exchange of opinions go with the territory,” says Atwood.
Like so many state plans, ISBI is grappling with the fallout from misguided decisions made during the late ‘90s bull market. As the value of retirement fund assets swelled, some now-suffering states -- among them Arizona, New Jersey, Pennsylvania and Texas -- dipped into their plan surpluses and hiked benefits to public workers. North Carolina used its pension surplus to cut its plan contributions and close a budget gap. But between mid-2000 and the end of 2002, pension plans were hit with the perfect storm: Equities sank, driving down the value of plan assets, while interest rates declined, increasing the present value of future plan liabilities.
In response, these states have deployed a variety of strategies to help close retirement plan funding gaps. Some, like the Massachusetts Pension Reserves Investment Management Board, have pursued more alpha-intensive investment strategies, often opting to boost their exposure to alternative assets. Others have concentrated their energies on better matching their assets to their liabilities. Virtually all public funds have in one way or another reassessed their asset allocation and investment strategies.
As Atwood moves to shore up the ISBI plan, his progress will be closely tracked by his fellow pension executives. Says Andrew Davis, vice chairman of the Chicago Stock Exchange, “Bill Atwood went from being the new kid on the block in the Illinois pension industry to someone who is recognized as a major player.” Adds Thomas Mackell, co-chairman of the National Advisory Council of Employee Benefit Professionals, an organization aimed at educating fiduciaries, “The guys at ISBI are stepping up as leaders in the industry.”
Certainly, the new ISBI executive director wasted no time in stepping up to the plate. After just four days on the job, he pulled a $190 million enhanced equity assignment held by an underperforming team at JP Morgan Fleming Asset Management. A month later, after meeting with his board of trustees, he dismissed Nicholas-Applegate Capital Management and TCW Group from small-cap equity mandates because he found their performance lacking. A representative for JP Morgan Fleming says the firm enjoys a good relationship with ISBI; Nicholas-Applegate confirmed the dismissal but offered no further comment; a TCW spokesman did not return calls.
Atwood knew he had bigger issues to deal with than simply replacing underperforming managers. He needed help overhauling the plan’s investment strategy. At the same meeting in which Atwood dismissed the money managers, he won approval from the plan’s trustees to hire ISBI’s first consultant. Several months later Chicago-based Marquette Associates got the assignment.
Resisting the governor’s pleas to place the new state contributions in conservative investments, the executive director temporarily parked the money in index funds. Then Atwood and his team, working with Marquette’s Brian Wrubel, spent several months overhauling the asset allocation strategy. The board approved Atwood’s ambitious plan in December.
Atwood’s new asset allocation aims to better diversify the plan portfolio while controlling its risk exposure. Determining that the currency exposure in the fund’s international equity mandate posed too great a risk for the returns it generated, he cut back the allocation. He also proposed new substyles in the stock and bond portfolios. Deciding that all bond portfolios should be handled by outside firms, he yanked $560 million from an understaffed in-house fixed-income team and moved it to an external passive manager. In addition, he recommended a new $500 million allocation to high-yield bonds and planned a move into hedge funds -- for the first time, ISBI will invest in the alternative asset class. Atwood aims to invest 5 percent of plan assets in funds of hedge funds and may place a $525 million mandate as soon as the end of this year.
Making tough decisions fast, Atwood has dispelled any lingering concerns that he lacked the financial experience to succeed as executive director. “I believe in taking action,” he says. “And if it doesn’t work out, you try something else.”
Occasionally, ISBI takes action on the corporate governance front. The plan joined New York and California pension funds in their campaigns to unseat CEOs Steven Burd at Safeway and Michael Eisner at Walt Disney Co. Burd and Eisner both held on to their posts, though Eisner lost his title as chairman of the board. “Corporate governance is a huge responsibility that can take up a lot of time,” Atwood says, “but you have to make the time.”
With help from resurgent equity markets, ISBI rebounded somewhat last year, returning 21.6 percent, versus a public plan median of 22.7 percent. Between June 30, 2003, and June 30, 2004, the plan returned 16.4 percent, compared with 16.3 percent for its benchmark.
Yet Illinois remains seriously underfunded. Despite the recent cash infusion, liabilities continue to grow. ISBI’s funding ratio has nudged up to just 57 percent, far below the public plan median of 79 percent. Still, Illinois has plenty of company in its misery. According to Wilshire Associates, as of year-end 2003, 13 other states reported funding ratios below 70 percent. The worst: West Virginia, which posts a ratio of just 40 percent.
Corporate pension funds confront similar challenges. They too suffered the one-two punch of falling stock prices and declining interest rates; as a result, many are running serious deficits. Some companies are funneling cash into their retirement plans to narrow funding gaps. General Motors Corp. did this most dramatically in the summer of 2003 when it floated $17.9 billion in debt to help close its plan shortfall. State funds, on the other hand, are at the mercy of legislators, who determine plan benefits and contribution schedules. That’s the chief challenge facing the executive director of any state pension fund.
Atwood’s peers are convinced he’s up to the challenge. “Bill Atwood inherited a tough job and has handled himself well,” says Jon Bauman, executive director of the Illinois Teachers’ Retirement System. “He’s the real deal.”
THE YOUNGEST CHILD OF A MUSIC STORE OWNER and a housewife, Bill Atwood learned early that life can be unpredictable and cruel. When he was nine years old, his family was shattered by the death of the eldest of the four children, Bobby, of testicular cancer at age 29. “He was someone I looked up to. It was very tough,” recalls Atwood.
After earning his BA in 1983 from Southern Illinois University in Carbondale, Atwood called Ralph Dunn, a Republican state legislator and family friend who introduced the aspiring politico to John Caldwell, a top aide to thenU.S. senator Charles Percy. Percy was the powerful and long-tenured Republican chairman of the Foreign Relations Committee who at the time was staffing an office in Carbondale as he prepared to face Democratic challenger Paul Simon. Atwood joined Percy’s campaign; the senator, however, lost his seat in November 1984.
Two years later, working for secretary of state James Edgar (who had served as chairman of the Percy campaign), Atwood was assigned to help the struggling campaign of Robert Gaffner. Gaffner was an Illinois Republican running for Congress in a special election. There Atwood met Mark Deschaine, a St. Louis money manager who was serving as Gaffner’s finance chairman. “The campaign was in a shambles when Bill showed up,” recalls Deschaine. Atwood quickly set up fundraisers, arranged meetings with community and business leaders and organized door-to-door literature drops. “I don’t overanalyze things,” Atwood says. “It’s a strength and a weakness.”
Gaffner lost by just 900 votes out of the 200,000 votes cast.
Atwood next landed a job with Republican governor James Thompson as liaison to the state Capital Development Board, which oversees construction of public works projects. When Edgar succeeded Thompson as governor in 1990, Atwood continued in his job at the Capital Development Board.
Two years later Atwood heard from Deschaine, whose $400 million-in-assets money management firm, Investment Counseling Inc., was looking to hire a sales executive.
“I knew from his personality that Bill would be great and that I could teach him,” says Deschaine.
Atwood accepted Deschaine’s offer and embarked on a new career. He did well as a salesman and eventually took over as de facto COO. “He never managed any money, but he did everything else there was to do at a money management firm,” recalls Deschaine.
When Atwood decided to move from St. Louis to Chicago in the fall of 1996, Deschaine suggested that he become a third-party marketer, working for ICI and other firms. Selling the services of various money managers to Taft-Hartley plans, Atwood learned the alpha and beta of portfolio management. But he wanted to take his career to the next level, and when he heard about the opening for the executive director position at ISBI, he applied for the job.
Both ISBI board chairman Edward Smith and trustee Jack Marco, a Chicago-based pension consultant, knew of Atwood’s strong reputation among union funds, and they brought him in for an interview. Though Atwood was competing against candidates with more financial experience, he impressed the board as a quick study. “I’m not a portfolio manager; I’m not a CFA,” Atwood told them. “But this job isn’t about knowing how to manage money. It’s about knowing how to pick good money managers, and if you want someone who knows how to do that, then I’m your man.”
That pitch persuaded the plan’s trustees, who are uniformly happy with their choice. “He’s uniquely qualified,” says Smith. Adds Marco: “Bill knows a lot about the money management industry, and he knows how to work effectively within the framework of a government bureaucracy. It’s tough to find the right person for this job -- but we did.”
ATWOOD ARRIVED AT ISBI KNOWING THAT HIS NEW role required political finesse. He reports to a nine-member board of trustees, most of them Democrats.
In May 2003, about two months after he took charge of the plan, he sent out requests for proposals for a consultant. At about that time, the Illinois treasury completed its sale of $10 billion in bonds, of which $7.7 billion was earmarked for the state’s three big pension plans. (The remaining $2.3 billion would cover banking fees, reimburse the state treasury for past pension expenditures and be placed in a sinking fund to prepay interest on the bonds.)
In late June, before the cash was doled out, a private political tussle between state politicians and pension officials burst into a public feud. Executive directors and trustees of the three pension plans made it clear that they intended to invest the bond proceeds as they saw fit; Governor Blagojevich and state budget director John Filan argued that for eight months or so, the money should be placed in Treasury bills or other conservative fixed-income investments. They urged pension officials to wait for markets to settle down in the wake of the Iraq War. After several private meetings between Filan and pension officials, a public forum at a downtown Chicago hotel drew dozens of union representatives and pensioners as well as pension officials and Filan, who was scheduled to address the group. But the budget director arrived late and announced that he was not going to speak after all. Soon after, the governor backed off and stopped pressuring the state pension officials.
“The governor has a right to express his opinion,” says Atwood, “and we have an obligation to listen. But we have a further obligation to exercise our own best judgment.”
ISBI’s $1.5 billion arrived on July 2, 2003. Atwood temporarily parked the money in index funds that mirrored the fund’s asset allocation structure. Then he focused on the plan’s investment strategies and systems, reviewing the performance of all its money managers.
He made some key changes in his 11-person staff, eliminating the positions of two in-house bond managers and declining to fill vacancies for CIO and head of fixed income. He hired Joy Winterfield of O’Connor Partners, a fund of private equity funds, to oversee the external managers handling private equity and real estate. Scott Richards, who had been in charge of private equity and real estate, was promoted to the newly created position of senior portfolio manager, overseeing all externally managed publicly traded securities.
As he tackled the plan’s asset allocation, Atwood was convinced that ISBI needed a consultant. He initially selected Chicago-based Ennis Knupp + Associates. The new executive director wanted a local firm that had no business other than consulting, and Ennis Knupp fit the bill. But Atwood insisted that the firm sign on as a co-fiduciary; it refused. Atwood then approached runner-up Marquette Associates, another well-regarded Chicago firm that draws revenues exclusively from consulting. Marquette agreed to become a co-fiduciary and was promptly hired.
Atwood’s new asset allocation, which the board officially approved in December, aims to bolster risk-adjusted returns, making changes in the broad strokes and tweaking the details.
On the domestic equity front, the target has declined from 46 percent to 45 percent; substyles have been rearranged and new ones added. Under the old framework ISBI’s roughly $4.5 billion domestic equity portfolio was split between large cap and small cap, equally weighted between growth and value. About $2 billion was indexed to the Standard & Poor’s 500 index, and about $2.5 billion was actively managed. In the new alignment the active component is biased toward value and core. Atwood says that the plan is aiming for an 11 percent annual return from domestic equity over the next five years with as little volatility as possible.
As part of its actively managed U.S. stock portfolios, ISBI made its first dedicated midcap allocation, of $750 million; it has a growth bias. “We’re less concerned with downside risk with midcap,” Atwood says. “We want companies that are going to grow into large caps.”
International equity falls from 15 percent to 10 percent, split between 7 percent large cap and 3 percent small-cap emerging markets. Bond targets nudge up from 23 percent to 25 percent and include a new high-yield allocation. Private equity falls from 8 percent to 5 percent, while real estate increases from 8 percent to 10 percent. Hedge funds jump from zero to 5 percent.
As he moves ISBI into hedge funds -- uncharted territory for the retirement plan -- Atwood is taking the funds-of-funds route traditional for first-time investors. He says he will probably sign up three funds of hedge funds, selecting the managers with help from Marquette consultant Wrubel. “The fees are fairly onerous,” says Atwood, “but we don’t have the infrastructure to run our own portfolio. Net of fees, we still think funds of funds can give us solid returns.”
Atwood is looking for transparency and will require that ISBI’s funds of hedge funds be registered with the Securities and Exchange Commission. “This is not a pure alpha play, nor is this absolute-return driven,” he says. “I see this as a proxy for U.S. equity, just a different style.”
Between Atwood’s new asset allocation and his reviews of all managers, a lot of money -- more than $3 billion -- has been in play. Already placed: an $825 million mandate to three midcap managers, Goldman Sachs Asset Management, New Amsterdam Partners and William Blair & Co; a $500 million high-yield mandate to Fort Washington Investment Advisors and Harris Investment Management Co.; and a $450 million mandate to six small-cap managers. A $375 million large-cap growth mandate, planned for one manager, is on the table.
On the horizon for this year or next: a $500 million mandate for core fixed income and $200 million for emerging markets. The $525 million for funds of hedge funds should be placed by the end of the year.
“It’s going to be a busy time,” Atwood says.
As a subcategory of all the various mandates, Atwood has earmarked $525 million for two specific groups: emerging managers -- firms that have between $10 million and $400 million under management -- and minority- or female-owned firms. The new policy comes in the wake of the state senate mandate to increase the diversity of Illinois’s money manager payroll. Atwood cites other motives, as well: “It’s our fiduciary duty to seek out the best investment professionals available. If we exclude emerging firms, you could say that we aren’t meeting our fiduciary duty.”
To date, he has landed one emerging manager. Cincinnati-based Opus Capital Management, owned by an African-American woman, Jackie Haussner, has signed on as a domestic small-cap equity manager.
“If all you do is invest with the Fidelitys and Alliance Capitals of the world, you’re only getting a certain kind of strategy,” Atwood says. “It’s mainstream talent, and that’s all well and good, but smaller managers not in the mainstream can be really creative and innovative. You want to find a role for them. If we wind up hiring minority- and women-owned firms as a result of this mandate, then that’s just an additional side benefit.”
Atwood says that in every choice he makes, “I’m trying to take a long-term view and not get caught up in a short-term focus.” That’s not easy to do at a public pension plan that is always in the eye of politicians, reporters, bureaucrats, state workers and retirees. Atwood is out to prove that despite his scant financial experience -- or maybe because of it -- he is up to the job.
