Our Take: The Tide Turns Toward In-Sourcing Public Pension Management

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A fascinating struggle that could ultimately redefine career paths for public pension fund investment professionals across the U.S. is playing out in San Diego.

Tired of losing key staffers to the private sector and seeing desks sit vacant because of legislated caps on what county employees may earn, the San Diego County Employees Retirement Association is trying a different tack. On Thursday it asked its board of trustees for permission to create as many as 17 new staff positions that would be exempt from rules that limit any San Diego county worker's total compensation to $330,000 or less. The proposal also would hike salaries and bonuses for some of the fund's 13 existing staff jobs.

Earlier, the $7.4 billion pension system had tried to sidestep the pay ceiling by outsourcing most investment work. Last September it inked a contract with Lee Partridge, who'd been deputy CIO at the Texas Teacher Retirement System, to serve as outsourced chief investment officer for a variable package valued at between $882,000 and $1.4 million. That contract was envisioned as a step toward outsourcing San Diego's entire investment team. But after the pension board shot down the idea earlier this year, fund Chief Executive Brian White reversed course and began looking at handling more, rather than less, investment work in-house.

Outsourcing Is No Bargain For Taxpayers

Partridge's pay package, which sparked outrage in the local press, illustrates that taxpayers don't get a bargain when they shift fund management expenses off-balance-sheet via outsourcing. But like many another public-sector financial decision, the move was driven by optics, not economics. Taxpayers, a.k.a. voters, often show far greater tolerance for a $1 million payout that's labeled a "fee" to a vendor rather than a salary or (heaven forbid!) bonus paid to a public employee. So do alumni, even of Ivy League institutions.

The underlying reason for all the machinations is obvious: San Diego County's municipal employee pay ceiling has prevented the county-run pension fund from competing for investment talent with private-sector fund management firms and endowments. A board committee examining staffing issues acknowledged as much when it asked White to look at ways of "filling the gaps" in staff (White blames three long-unfilled vacancies on the pay cap). What's more, the fund has had five CIOs in the past 15 years.

Similar Issues Playing Out at Other Public Fund Systems

Other public pension systems face similar compensation-related staffing challenges. In Massachusetts, Michael Travaglini resigned as head of the state's pension fund in May to join Grosvenor Capital Management, a Chicago-based hedge fund, as a managing director for business development. He blamed proposed legislation that would restrain pay for Massachusetts state employees who earn more than the $143,000 governor's salary and block performance bonuses for years when the fund's overall returns are negative. "There's a real threat to not being able to recruit and retain competent people here," Travaglini told the Boston Globe."People can vote with their feet, and that's what I'm doing."

Within the past year, elected officials in California, Texas and Ohio forced public funds to alter retirement fund employees' pay formulas in ways that erode the long-accepted tie between compensation and fund returns relative to benchmarks. In June, the board of the $201.9 billion California Public Employees' Retirement System (CalPERS) adopted a new policy giving itself the power to "defer, reduce or permanently strip" formula-based bonuses for its staff for any future year when the system has negative performance. The CalPERS board rejected consultant Mercer's recommendation to throw in a bonus sweetener for years when its employees achieve exceptionally high returns for the fund.

Such measures stem in large part from voters' frustration at seeing public fund employees receive bonus payments for outperforming a sinking market in 2008 and the first half of 2009. But they also reflect politicians' irresponsible tendency to promise constitutents something for nothing. "My retirement fund lost money - take it out of the fund staff's hide!" is an appealing slogan whose air of unreality was conveniently obscured by the crisis-induced hiring drought for investment professionals.

Now that the financial crisis is fading, the laws of supply and demand for talent are reasserting themselves. With fund management firms hiring again, staff turnover at low-paying public-sector funds looks to accelerate especially at more-junior levels. That makes San Diego's ongoing struggle with pay restrictions a national bellwether.