After Scandal, DiNapoli Steadies New York Common Fund

Name: Thomas DiNapoli

Role: New York State Comptroller; Elected fiduciary of the New York State Common Retirement Fund

Assets: $147 billion

Private Equity: 9.5% of assets; $13.9 billion in invested capital

Annual Return (as of June 30, 2011): 21 percent

When Thomas DiNapoli was appointed New York’s comptroller in 2007, all hell was about to break loose. Alan Hevesi, DiNapoli’s predecessor, would turn out to have had a central role in a pay-to-play scandal at the New York State Common Retirement Fund, an offense for which Hevesi was sentenced to one to four years in prison.

The first order of business for DiNapoli was damage repair: setting up new procedures and ethical standards to ensure that no offense of this kind would ever again tar the reputation of the nation’s third largest pension fund.

With solid investment management, returns at the $147 billion fund have been strong, certainly enough to recover most of the losses suffered during the financial crisis. Meanwhile, the pension has cemented its status as one of the nation’s best-funded pensions, even as it serves more than one million public employees and retirees.

DiNapoli sat down with Gregory Roth, senior editor at Buyouts, to discuss the challenges of moving his giant pension fund toward a more solid ethical and financial footing.

What was your biggest surprise coming in to your role?

I was appointed by the legislature in February, 2007, after my predecessor, Alan Hevesi, resigned. I inherited an office that was very quickly going into a crisis in terms of public perception of how we did things, and that required significant overhauls of procedures, policies and personnel. When you’re reading about your office in the paper every day, it’s not a great morale booster.

I also don’t think that anybody could have forecast the meltdown of the housing market and the collapse of the public markets on Wall Street.

What are you most proud of during your stewardship of the nation’s third largest pension fund?

Survival, first of all. We’re still the nation’s third largest pension. And we’re one of the best funded, even with all the challenges out there. I’m also proud of the fact that we’ve turned around the reputation of the office from an ethics point of view, and that our reputation has been restored in terms of our ability to perform. We do our work in a way that not only seeks great results, but we also understand that we have to do things the right way.

Describe your office’s efforts to bolster ethics following the travails of your predecessor, Alan Hevesi, who’s now serving time in prison. What have you done to make sure that pay-to-play issues never happen again?

After first adopting a disclosure requirement, it soon became clear that disclosure wasn’t enough, that we had to go further. So we took the step of banning any transaction that involved a third party in terms of placement agents, lobbyists or paid intermediaries of any kind.

The SEC contemplated doing this as well, but it got tremendous pushback, and they haven’t adopted that as a regulation. We have it in New York, and I’m fully committed during my tenure to maintaining that. That has been the most tangible and specific change that I’ve implemented that will ensure that what caused the problems during the Hevesi period won’t happen again.

But the biggest difference, I think, is the tone that I try to set, which is that ethics matter. It’s not just about getting a bottom line result; we have to do things the right way.

Has your ban on placement agents led you to worry that you might be missing out on smaller, strong-performing private equity funds that don’t have their own marketing departments?

That’s not a concern I share. First of all, we’re big and we’re kind of well known. If someone really wants to find us, they don’t need a marketing department to get to us. As for newer and smaller firms, we have a very aggressive emerging manager program, particularly in private equity. I’m confident that [the ban] doesn’t preclude our exposure to new firms and niche markets. In fact, our emerging manager program probably more effectively gets us there, as opposed to waiting for someone to come knocking on our door.

The ban on placement agents eliminates a role that, in many cases, probably wasn’t required from our point of view. And it certainly eliminates what had been a high risk area for us in terms of reputation. Clearly there were problems in other states as well. Whatever risk there may be of arguably not having access to certain funds, it is far outweighed by the risk of working with placement agents and finding out three years later we had some of the same problems again. And, having gone through the Hevesi investigation, that’s the risk I most want to minimize.

New York has a strong focus on emerging managers. Do you think there is a big enough pool of emerging funds out there, so that the investments you choose are, objectively speaking, the very best investments that the pension fund can make?

We’ve had a good track record. There are always new firms coming in, and we want to be plugged into them. I do think there are enough, but I think it’s important for us to be on top of who is out there. When you look nationwide, I think there is an adequate pool, and it’s a growing pool. And by having our capital available, we hope to grow that pool. Our experience overall has been positive. Obviously, there are many people we say no to. As long as we’re being selective, I’m confident we’ll get the right returns. And the goal with the emerging manager program is to graduate folks into the mainstream of our investments.

Doesn’t the New York State investment program have at least as much of a political and economic goal as it does the goal of achieving pure investment performance? It seems you’re trying to do two things at once.

Again, the results have been very strong. We’re not just doing this for the sake of saying we have investments in New York. It certainly is a double bottom line approach. From my point of view, we’re invested nationally, and we’re invested globally, but let’s not overlook the great opportunities there are here in New York. If we can help grow New York companies and, by extension, to grow jobs in our own state, that helps the overall economy, which is good for everyone.

What most keeps you up at night, as far as managing the billions of dollars in assets that you oversee?

There’s obviously so much beyond our control in terms of the volatility of the markets, so I think there’s a lot to keep us up at night. But what gets me to sleep is the recognition that we have the luxury of a perpetual investment horizon, and that our asset allocation model is based on a level of diversification set up to weather the ups and downs. We’re not day traders, so we can ride out the ups and downs. We’re also trying to be less dependent on the markets. Because we’re a big ship, we move slowly, and by reducing our exposure to public equities, we’ll be even less affected by that volatility.

Through June, the New York Common fund returned about 21 percent, which compares well other large pension funds. Are there any plans to increase your asset allocation toward private equity, with the caveat that there’s more risk involved?

That’s exactly what our goal was in our last allocation review in 2009, which was to boost private equity and real assets like infrastructure, commodities and timber. Our private equity allocation target is 10 percent, and we’re currently at 9.5 percent. We have about $14 billion in invested private equity capital. Our goal is to have less exposure to the volatility in public markets. And since we are a long-term, patient investor, I still am very strong on private equity as an alternative investment that has worked well for us.

Has your office made an effort to reduce the fees that the pension pays to private equity managers?

The short answer is yes. When we have an opportunity to try and get more favorable terms on fees and conditions, we try. But when you have an opportunity with a fund that is best in class, they can easily say, “No, thank you. We’ve got other pensions ready to take your spot if you don’t want it.” Everybody assumes that because times are tighter, we have more leverage. The reality is that, with the best funds, they can pick and choose as well. So, if you push back too hard, you may lose the opportunity.

What, in your opinion, is the fairest way to tax carried interest?

I would err more on the side of treating it like taxable income. The way it’s been taxed in the past has been an advantage [for general partners] at a time when there’s a lot of focus on gaps in wealth. I personally think that advantage probably doesn’t make sense today. I still think folks [in private equity] will still be making plenty of money.

What do you think about the people demonstrating in New York as part of Occupy Wall Street?

There’s a lot of frustration and anger, and a perception that American taxpayers helped get Wall Street and the banks back on their feet, and that they’re doing well, and they’ve rebounded, while so many other sectors and so many individuals and families haven’t. I think it’s an emotional, visceral reaction to a perception that folks on Wall Street, some of whom are responsible for very poor decisions and risky behavior that brought the economy to its knees, are doing fine today, while so many others are not.

Yet, the financial services industry is a very important part of our economy. And sure, if you have a job on Wall Street, you’re doing great—you’re doing better than just about everybody else. But if you’re among the 8 percent of New Yorkers who are unemployed and have been for a while, and you know that the average securities worker earns an average salary of $350,000, you’re not going to be feeling too bad for them, even if a few thousand of them are going to lose their jobs. The reality is that we need Wall Street to be strong and profitable. We also need the unemployment numbers to go down. The national discussion needs to move toward to a more inclusive strategy that keeps financial services strong while putting more people back to work everywhere else.

Because of the recent departure of Raudline Etienne, your former chief investment officer, you now have an important vacancy to fill. What are you looking for in your next CIO?

Certainly someone who’s got investment experience, either in a public plan like ours or in a private plan. Also, managerial skills. And I think a fundamental requirement, from my point of view, is a sense of ethics because of the recent history here.

There have been a number of high profile departures at pension funds of late, including Wisconsin, Oregon and New York. Do you find it hard to attract and retain high-quality people when private sector compensation is so much higher?

It is harder to hire now because the private sector has come back. There were a couple of years when working for the pension fund was a safe haven. But there still are people who understand that working in a public fund is a wonderful opportunity, not only in terms of experience, but in terms of being a part of something that is not just about making money, but about providing retirement benefits for public workers.

What’s the most important thing that a private equity firm can do to get noticed by your office for an investment?

It’s always great when you have a track record. Also, understanding what our needs are. Very often people say they have this great opportunity, but if it doesn’t fit in with our needs, then it’s just not what we’re looking for. Patience is another thing. Very often people come to us when they’re fundraising and say, “You know, it’s got to be done in sixty days.” Well, we’re a pension fund. We don’t work on your time frame. You have to work on ours. And if therefore you don’t want us as a partner, fine. A little more sensitivity and understanding of our due diligence process would be helpful.

The New York Common Fund has the luxury of being one of the best funded pensions in the country. But what would you say to a pension fund like Illinois, which is less than 50 percent funded?

First off, I’m glad we’re not in that situation. One reason why we’re not is that we’ve paid our bills. Many states, like New Jersey, didn’t pay their bills. And then you had a period like 2008 and 2009, where you have this terrible loss. If you haven’t paid your bills, and you have this terrible loss on top of that, all of a sudden, you have this severe underfunding. In many places, what’s being talked about is changing the benefit structure. But it’s very hard to undo years of not paying your bills. It’s certainly not going to happen overnight.

What do you wish people better understood about the fund?

I wish people better understood that 83 cents out of every benefit dollar is paid from investment returns, not taxes or employee contributions. I also wish people realized that the New York Common Retirement Fund is better funded than most other state funds. When people hear negative things about public pension plans, I would like them to realize that New York is not in that category.