Pay for performance

Generating an annual return of nearly 20 percent would earn most finance professionals a hefty bonus. But not if they work for the California State Teachers’ Retirement System.

CalSTRS Director of Private Equity Margot Wirth led a team that generated a 19.6 percent return during the 2013-2014 fiscal year. Her reward? A bonus of just $29,392 – less than half the average bonus received by public pensions’ private equity directors last year, according to an internal Institutional Limited Partners Association compensation survey obtained by Buyouts.

To its credit, CalSTRS has since revised the system it uses to calculate bonuses. Given how difficult it is to attract and retain elite PE pros, it is likely that other public pensions will review their bonus programs, too. Buyouts spoke with several public LPs and found that all of them offer incentive pay, but the manner in which they assess and grant bonuses differs widely.

Take CaSTRS, for instance. To assess the size of its staff’s bonuses, which range from 15 percent to 100 percent of each staffer’s base pay depending on rank, it assigns a 50 percent weight to the performance of each staffer’s asset class against its benchmark, 30 percent to total fund performance, and 20 percent to the personal performance component, spokesman Ricardo Duran told Buyouts.

The retirement system’s private equity holdings outperformed its overall investment portfolio by almost a full percentage point, but historically strong equity markets pushed CalSTRS’ private equity benchmark, a modified Russell 3000 plus three percentage points, to 26.4 percent as of June 30. The PE portfolio’s actual performance trailed the Russell benchmark by more than six percentage points. (The $187 billion retirement system’s overall portfolio also failed to clear its respective benchmark.)

As a result, CalSTRS did not award any incentive pay related to private equity or total portfolio performance. 

CalSTRS’ five private equity portfolio managers received bonuses equal to roughly 10 percent to 13 percent of their annual salary, despite being eligible for as much as 60 percent to 75 percent. One of those managers, Mahboob Hossain, left CalSTRS for the California Public Employees’ Retirement System in September.

“We realize there is a bit of a disconnect between our performance vs. the benchmark we had been using, which was a public benchmark,” Duran said. “The benchmark that we were using wasn’t the best.”

CalSTRS determined that its modified public equity benchmark did not fit the long-term investment profile of its private equity portfolio and switched to State Street’s GX Private Equity Index in July. Rather than judging the private equity portfolio’s performance against public companies, the new benchmark index tracks performance at roughly 2,300 funds representing $2 trillion of private equity investments.

“The new benchmark is based on the realization that private equity needed a more accurate measure for the short term, so that’s why we went with the State Street index,” Duran said.

The retirement system will calculate future bonuses against the new benchmark. It did not assess if its private equity portfolio would have cleared the new State Street benchmark during the 2013-2014 fiscal year, and it has no plans to reassess its investment staff’s 2013-2014 incentive pay against the new benchmark, Duran said.

California’s other major pension system, CalPERS, also weighs investment performance and a qualitative assessment, though with a weighting system that takes into consideration individual positions as well as overall portfolio performance in awarding bonuses.

CalPERS granted private equity chief Réal Desrochers more than $176,000 in incentive payments on the year, an amount equal to roughly 62 percent of his maximum allowable bonus, according to retirement system documents. Its private equity portfolio netted 20 percent for the fiscal year ending June 30, underperforming its benchmark by 331 basis points.

Other pensions, such as the Oregon Public Employees Retirement Fund, which is managed by the Oregon State Treasury, tracks its performance against peer institutions rather than modified public or private market benchmarks.

Oregon’s investment staffers are eligible for bonuses of up to 30 percent their base salary. Once their investment performance clears the 45th percentile of public pension portfolios tracked by the Trust Universe Comparison Service (funds that fall within the first percentile are top performers), their incentive pay grows 1 percent for each percentile it improves, with a cap at the 15th percentile.

“Our compensation benchmark is a peer group, and that’s a reflection of how hard it is to benchmark private market assets,” said John Skjervem, CIO of the Oregon State Treasury.

For its part, the Teacher Retirement System of Texas awards bonuses using a hybrid policy that accounts for both market and peer performance. Texas Teachers’ attaches a 50 percent weight to performance against benchmarks, a 30 percent weight to performance against peer groups and a 20 percent weight to a qualitative assessment, according to its compensation policy.

While many public pensions offer staff incentive pay, others have opted against the policy because of budget shortfalls or political reasons.

One public pension LP said its board’s decision to not grant bonuses stemmed from its investment portfolio’s poor performance through the financial crisis. Many state employees’ salaries froze, and rewarding staff for generating negative returns struck its board as inappropriate, the LP said. 

That attitude appears to be an outlier, however, as a majority of limited partners award performance-based bonuses, according to the ILPA study.

Bonuses are only part of the equation, however. The New Jersey State Investment Council, which manages about $80 billion, has worked hard to fill vacancies, but salaries remain a challenge.

The Garden State this year managed to hire Corey Amon as a new deputy director after he worked as assistant treasurer at Ryder Systems. But overall, the investment council “believes that compensation levels for senior investment professionals should be raised, in order to better compete, if not with Wall Street (which would be impossible), at least with other pension funds and endowments,” said Bob Grady, former chairman of the Investment Council, who stepped down on Nov 19.

While the Division of Investment and the State Investment Council developed a proposal to increase compensation and presented it to the state treasurer, the legislature has yet to pass any changes in pay, Grady said.

Meanwhile, the state has been seeing a fair amount of turnover. Division of Investment Director Tim Walsh stepped down to take a position with real estate firm Gaw Capital in 2013. This past March, Chris McDonough was named director of the investment division.

Bonuses are an important tool for public systems to retain talent because the best private equity investment officials have the constant temptation of moving into the private sector and making more money. Big salaries can be hard to approve at public systems, which are under constant scrutiny by the public and various interest groups. Incentive-based pay tied to performance may be the best – and only – way a big public system can keep staff members and institutional memory, preventing a “brain drain” to the private sector.

Steve Gelsi contributed to this story