Pension plans see modest increases

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Pension plans see modest increases

By Joseph N. DiStefano, the Philadelphia Inquirer

September 2, 2003

Managers of public-worker investments try to find the right mix of index funds and active money advisers.

After three years of losing money, last spring's Wall Street rally modestly boosted the value of investments at the region's biggest pension plans, enabling their newly appointed managers to post small gains for the last fiscal year.

But the managers of these public-agency investments know they will need more than a good quarter or a modest boost to prevent big increases in taxpayer subsidies for the plans, which fund monthly checks to more than 300,000 retired teachers, legislators, and other government workers in Pennsylvania and New Jersey.

"Anytime you go through a prolonged downdraft, you do learn a lot of lessons," said Alan Van Noord, who is completing his first year as the Pennsylvania Public School Employees' Retirement System's chief investment officer, after leaving a similar job at Michigan's state pension fund.

Under Van Noord, the $42 billion-asset fund has moved $1 billion away from private money managers into low-cost accounts tied to Standard & Poor's stock indexes since last summer. Although the fund still employs more than 150 outside stock, bond, real estate and private-equity management firms, at a cost of more than $150 million a year, "indexing is really our base," accounting for 62 percent of the fund's $24 billion in stock investments, Van Noord said last week.

As Pennsylvania's fancy plan is getting a little more vanilla, New Jersey is considering adding side dishes to its meat-and-potatoes pension system.

At the $76 billion New Jersey Division of Investment, director Peter Langerman, appointed last fall by Gov. McGreevey, is awaiting next month's audit by Independent Fiduciary Services, of Washington. His system, the largest U.S. investment fund run entirely by state workers, invests mostly in stocks and bonds, at a cost of less than $10 million a year. "We're looking for ways to diversify it. In many cases that might look like [hiring] external managers," State Treasurer John McCormack said.

Meanwhile, Langerman has scrapped old rules that permitted trading only on Tuesdays, and the board he reports to - now dominated by McGreevey appointees - meets monthly, up from four times a year.

"Investing is not rocket science," said Langerman. "It's reading the annual reports. It's reading the news. It's reacting. There's a mental approach, it's a discipline." Langerman, a Yale honors graduate, is a onetime bankruptcy lawyer, veteran corporate director (he fired confrontational CEO Al "Chain Saw" Dunlap from Sunbeam Corp.), and past head of the $20 billion-asset Franklin Mutual Advisors.

New Jersey and Pennsylvania both increased public workers' pensions at the end of the 1990s, in the expectation they would be able to keep posting investment gains averaging more than 8 percent a year. But this year's gains, while better than prior losses, still fall short of that goal.

For the 12 months ended June 30, New Jersey reported a 3.3 percent gain on its investment portfolio, compared with 2.7 percent for Pennsylvania's Public School Employees' Retirement System. (By comparison, the Philadelphia pension fund, which faces a growing deficit, was up 2.4 percent; the California state pension fund, the nation's largest, was up 3.9 percent.) Those gains came during the spring, when the market's revival wiped out last fall's losses. Indeed, for the first half of 2003, the stock-heavy school employees' system returned 9.2 percent, outperforming both New Jersey, which gained 8.7 percent, and the Pennsylvania state workers' fund, up 8.5 percent.

Checking the books

The Pennsylvania pension plans employ so many outside money management firms that they sometimes end up canceling each other out.

For example, school employees' system funds held 5.94 million shares of Citigroup Inc. at the end of last year, almost unchanged from a year earlier. But during the year, the system's investment pros bought or sold more than three million shares of Citigroup stock. Hired managers such as MacKay Shields, Putnam Investments and Deutsche Bank each sold 100,000 shares or more of Citigroup from teachers' pension accounts, even as Alliance and J.P. Morgan were buying comparable blocks of shares, also for the school employee system.

State records show similar self-canceling trades of General Electric Co. and Microsoft Corp. shares, among other major holdings. Some of the changes represent funds going out of private managers' accounts and into the state-run index funds, which operate at a fraction of the cost of private managers.

"When you have multiple managers, you can theoretically have a manager that's selling and a manager that's buying" at the same time, Van Noord acknowledged. For example, "the value manager says, 'It's too expensive, I will sell,' while the growth manager says [the same stock] 'is attractive, I will buy.' "

The same thing has happened from time to time in New Jersey, according to state treasurer McCormack. "We would have domestic analysts selling auto parts [stocks] while foreign analysts were buying," he said. To prevent such overlap, investment chief Langerman "has the analysts talking more to each other," McCormack said.

While indexed funds generally beat private managers during the 1990s bull market, active managers for the school employee system occasionally beat the indexes. "We had a very good quarter" from April through June, Van Noord said. While the S&P 500 rose 15 percent, the fund's private managers did even better, boosting equities by 17 percent. And a group of 13 smaller "developmental" fund managers, based in Pennsylvania or run by women or minorities, returned nearly 19 percent.

Pennsylvania Auditor General Robert P. Casey Jr. wants a closer look at the way private managers are hired at the school employee system and its sister fund, the $21 billion Pennsylvania State Employees' Retirement System. The funds and State Treasurer Barbara Hafer oppose Casey's planned audit, and the two sides are scheduled to argue their cases in Commonwealth Court in Harrisburg on Sept. 10.

Last winter, the Pennsylvania teachers' fund told state and school officials it would likely have to impose a 10.5 percent pension surcharge on teacher payrolls next year - triple this year's level and eight times what they paid in 2001-02.

The increase will be partly paid by property owners through the school tax. The expected increase would cost about $20 for every $100,000 in assessed home value, according to suburban school officials. That was based on the expectation that the investments would return 2.5 percent during the last fiscal year, Jeff Clay, acting executive director, said. Because the system did slightly better than that, the tax increase might be a little less, he said.

The Pennsylvania state workers' system told legislators in March that it expected to need a subsidy equal to 2 percent of the state payroll this year - and that the levy would rise to nearly 9 percent next year. (In addition, state workers typically pay 5 percent to 7 percent of their income into the pension fund, money that also comes from state taxpayers.)

But on Thursday, spokesman Sean Sanderson said the state workers' fund had revised its projections, and needed a state subsidy equal to just 1 percent of payroll this year, plus an estimated 3.5 percent next year, in addition to the workers' contributions, which continue at last year's levels. Tom Wanich of the pension system's Office of Member Services credited a pay freeze negotiated with state workers' unions for reducing future pension expenses, which are based on workers' preretirement pay.

New Jersey expects to resume direct pension fund subsidies, which stopped when then-Gov. Christine Todd Whitman sold bonds in a gamble to boost the pension fund during the 1990s.

Already the state workers' payroll pension deduction has been increased, from 3 percent to 5 percent. But pension bond repayment costs are expected to require additional state contributions of $730 million, and possibly more, over the next five years, said Tom Vincz, a spokesman for the state treasurer's office.