Politicians, fraud and investment professionals at New York State’s $124b fund

Most public sector pension funds are subject to some sort of political interference, notwithstanding the best efforts of fund trustees and staff. Few, however, can rival the experience of America’s third-largest fund, the New York State Common Retirement Fund.

Last week the fund’s sole trustee, Thomas DiNapoli, a Democrat politician, applauded the successful prosecution of his predecessor on the felony fraud charge of accepting bribes.

The hapless predecessor, Alan Hevesi, a fellow Democrat politician, vacated the position in December 2006 after admitting he had used state employees to chauffeur his ill wife for two years. He was fined $5000 and paid $200,000 in restitution. Now aged 70, Hevesi has also pleaded guilty to accepting gifts in return for favouring certain funds managers, following an investigation by New York Attorney General Andrew Cuomo.

Cuomo had already taken the scalps of six others involved in the pension fund following Hevesi’s departure, including that of David Loglisci, former chief investment officer, who pleaded guilty to a corruption charge.

But from a pension fund governance perspective, the story is only just starting to get interesting.

Cuomo’s predecessor as Attorney General, Eliot Spitzer, who later suffered his own controversy because of loose paid-for sexual encounters, was critical of DiNapoli’s appointment as New York’s Comptroller in February 2007. The Comptroller’s state auditing oversight also made him sole trustee of the big pension fund. Spitzer, a zealot for financial, if not personal, purity and probity said DiNapoli was too inexperienced for the role.

Now Cuomo, who is running for the position of New York Governor, has said he would abolish the sole trustee role of the fund and replace it with a more traditional board or oversight committee.

So, too, intends Harry Wilson, a Republican, who is opposing DiNapoli at next month’s election.

The two appeared in a televised debate last week, which included barbs going each way to do with management of the pension fund. Wilson attacked the fund’s performance while DiNapoli played the man. DiNapoli said Wilson, a Wall Street private equity executive, had the sort of values which had pushed the economy into recession and hurt the pension fund.

DiNapoli also produced a statement, separately, following news of Hevesi’s felony plea in which he applauded the actions of Cuomo and his staff for holding accountable those individuals who were responsible for compromising the Office of the State Comptroller.

He said: “My predecessor, Alan Hevesi, is the latest in a line of corruption that just keeps getting longer. It’s time to take away the pension of anyone found guilty of committing a felony in the course of his or her official duties. No-one who violates the public trust so egregiously should be allowed to receive a taxpayer-funded pension.

“Attorney General Cuomo’s diligent investigation has brought to public view the crimes of the Hevesi administration. The steps I’ve taken implement reforms to protect the fund from abuse. But Alan Hevesi’s guilty plea as a result of the Attorney General’s investigation is a stark reminder of the need for constant vigilance.”

DiNapoli has taken several steps to reform the governance and transparency of the fund. He lists them on the fund’s website in case you missed the many press releases of the past three years. He banned the use of placement agents and lobbyists by the fund, prohibited ‘pay-to-play’ campaign contributions and improved the detail in and increased the frequency of reports.

He even commissioned an audit, by Mercer, of the 131 transactions which took place in the first two years of his watch as trustee. Just one minor compliance violation was discovered.

But he is still the sole trustee, which may be a reform – through the appointment of a board – that someone else will have to introduce after next month’s election.

The pension fund’s performance has been broadly in line with other large US-domiciled funds in the past few years. New York State CRF has beaten the country’s two larger funds, CalPERS and CalSTRS, over the past one, three and 10-year periods.

However, each fund has suffered badly at the hands of the global crisis, across equities, real estate and alternative asset classes.

With New York State, the US equities performance has slightly lagged the Russell 3000 index in one, three and five years, but beaten it over 10 years. But the performance is much better than this implies. About three-quarters of the fund’s domestic equities is indexed by a low-cost in-house management team, so after-fee after-tax performance is probably a lot better than most of its peers.

The external US equity managers are selected with the assistance of consultant Ennis Knupp & Associates, following a core-plus-satellite strategy. The fund also invests in a fund-of-funds program with Progress Investment Management and another with FIS Funds Management for emerging and minority-and-women-owned equities houses.

In response to recent criticism that the fund would have been better off investing in cash and bonds, DiNapoli’s office responded early this month with a report which showed that it is actually much better off with its balanced growth/defensive (70/30) approach over the past 20 years. A bonds-only allocation would have reduced the fund’s size by $56 billion in that time, requiring an additional $33 billion in employer contributions to cover liabilities.

The fund has relatively strict legal limits on its asset allocation, which is perhaps another questionable governance issue going forward. It can invest no more than 70 per cent in equity assets, within which real estate and alternatives are included. Of this, only 10 per cent can be international, 5 per cent in real estate and up to 25 per cent “in any investment that meets prudent investor standards”.

The fund actually exceeds some of these limits at the moment but this is authorised as long as they meet the prudent-investor standard.