The investment team at the $10 billion Kentucky County Employees Retirement System (CERS) had their hopes of making an additional investment in an oil and gas fund run by investment manager Kayne Anderson dashed at a specially convened board meeting at the end of April.
Broadcast on Facebook from the fund’s Frankfort offices, the board and investment committee meeting process not only revealed trustees’ new reticence towards oil and gas assets in the current economic climate. In a show of tension between the board and investment staff, it also highlighted trustees’ concerns about their ability to conduct robust due diligence in a hurried timeframe and lacking input from the pension fund’s external consultant, Wilshire Advisors.
CERS – like its smaller, severely underfunded sister fund the Kentucky Employees Retirement System (KERS) – is managed by the Kentucky Public Pensions Authority (KPPA). However, governance at CERS and KERS was formally separated in 2021 and each pension fund now operates with its own independent board of trustees.
KERS approved the same investment at its board meeting the day before.
KPPA staff CIO Steve Willer and deputy CIO Anthony Chui laid out compelling reasons to invest in the fund which boasts commitements from a raft of other US public pension funds like the Teacher Retirement System of Texas and San Bernardino County Employees’ Retirement Association. They described its differentiated strategy, favourable risk-adjusted return and low correlation to other real return investments in the public and private portfolio.
CERS has invested with the manager before, but the previous strategy was more venture-focused and backed teams to buy acreage and explore. This time, CERS would be tapping into an asset that is already producing high levels of income. In contrast to other private market investment where capital calls can sometimes take several years, CERS capital would also be called quickly.
The strategy hedges production – currently “in the $70s” – three to five years out in a rolling approach that lowers investors’ exposure to volatile commodity markets and “makes it look like fixed income.” Oil is currently around $60 a barrel.
Willer and Chui argued that the lack of capital flowing into energy due to “investment restrictions” on many pension funds also means that those investors who do provide capital to fossil fuels can earn a significant return.
“There is underinvestment in the traditional energy space,” said Willer.
However, CERS trustees poured cold water on the strategy. They voiced concerns about the oil price, arguing it could come under pressure because of demand uncertainties prompted by tariffs as well as boosted production flowing into the market from the Middle East. Despite the hedged strategy, if oil and gas prices are subdued for any length of time it would effect the overall return. Moreover, the strategy breaks even with oil priced at $60 a barrel, yet the assets could require additional investment and costs to maintain production because they are not new wells.
“We don’t understand [the impact of the tariff issue] on industries like this,” said Merl Hackbart who serves on both the investment committee and board of trustees, adding: “There is a history of continuing these investments [in established wells] for longer than what is intended.”
Board frustrations
Committee members also expressed their frustration with the staff because the special meeting to review the investment had been called at short notice. It meant board and investment committee members were absent, yet a full board (of six members) must be present to make investment decisions.
One member struggled to hear the conversation because he had joined the meeting whilst driving his car.
“Why have we got to make a decision so quickly? How long have you known about this opportunity?” asked Backhart.
“The other issue that stood out for me was the short timeframe we were given to look at this,” agreed George “Lisle” Cheatham, chairman of the CERS board of trustees.
Staff responded that they had been exploring the opportunity for a “long time” but had only recently taken reference calls and “done the leg work” on contract terms. Now they needed to “act quickly” because it was the final close date for capital commitments.
The investment committee also expressed concerns at the lack of input from the pension fund’s consultant Wilshire Advisors, asking why the advisors had “not [been] brought in earlier” to provide insights and expertise.
“What other opportunities are there out there compared to energy and how do they stack up,” asked Cheatham, who said the investment had “a lot of” unanswered questions. “There are probably better opportunities in different areas – what are they? Given the market uncertainty now, is real return one we should be looking at compared to others?”
Trustees also raised concerns about the allocation taking CERS over its strategic asset allocation of 7 per cent to real assets. If 100 per cent of funds were called today, the allocation would be overweight by around 8 per cent.
“Hopefully at the next opportunity to get everyone together [we will be] aware of what we are looking at,” concluded Backhart.
