The Failure of Private Equity Investments at NYCERS

Below are two screen shots from the June 17, 2025 NYCERS Investment meeting. The charts displayed were prepared by the Comptroller's office and presented to the NYCERS trustees.

The first chart alleges to show the rate of return on alternative investments in the NYCERS investment portfolio. The second chart alleges to show the rate of return relative to their targets measured in plus or minus basis points.

The Comptroller provided no documentation on how the amounts were arrived at. I consider the amounts in these charts to be inflated because the values listed were provided by the general partners running the individual investments and are just estimates.

But even accepting the figures as correct, we see a huge problem with the private equity class. For over ten years it has been 300 basis points (3%) under its target of the Russell 300 plus 300 basis points.

In plain English, NYCERS private equity investments performed exactly like a Russel 3000 index fund.

As of June 30, 2024 NYCERS reported:

• a Russel 1000 index fund worth $12.9B
  • with an investment fee of only $269,000 for FY-2024, and
• private equity investments at a value of $8.46B
  • with $163.4 million in investement fees plus $64.8 million in organizational costs for FY-2024.

On top of this obvious performance failure, the index fund is totally liquid and pays dividends every year from all the stock holdings in the fund.

The trustees are aware of this situation but continue to hire private equity managers. They did, however, dump some private equity managers in March of this year.

Climate Change - Private Equity - NYC Comptroller

On October 22, 2024, Comptroller Lander announced a proposal to curtail the activities of private equity firms that enter into future contracts with three of the NYC pension funds. Police and Fire funds are not part of the proposal.

Conceptually this is a positive effort in dealing with climate change. It is, however, not possible to put into effect.

I have been critical of private equity investments for a long time. They are expensive, high risk, illiquid, and, on average, less effective than the S/P 500 index. They are also black box operations that limited partners have no control over. Limited partners, like the pension funds, commit money to the partnerships and hopefully many years later get their money back and possibly some positive return.

The pension fund trustees have no access to the private equity contracts that the Comptroller signs with private equity partnerships. They are “trade secrets”. Once the Comptroller signs the private equity contract, he has no idea what investment decisions that the general partner makes. He also cannot terminate the contract. The idea of restricting the general partner’s decision is not possible.

I will give Lander the benefit of the doubt and assume that he is not aware of the workings of private equity. That is, however, a scary assumption concerning the investment responsibilities of the NYC Comptroller.

A serious climate change initiative would be to no longer enter into new private equity contracts. It would also be a money saver.

A Better Way: $92B rather than $81B

Assest Allocation

The most important decision that the NYCERS trustees make is the investment asset allocation of the funds of the trust. The asset allocation is a list of types of investments and the percentage of funds assigned to each type or class. Currently the trustees have chosen a complicated and very expensive allocation. The current list of classes and percentages is as follows:

1. US Equities -28.6%
2. International Equities – 11.5%
3. Emerging Market Equities – 4.9%
4. Fixed Income – Structured – 20.9%
5. Fixed Income – High Yield – 4.1%
6. Fixed Income – TIPS -3.3%
7. Fixed Income – Converts – 1.8%
8. Private Equity – 10.5%
9. Private Real Estate7.3%
10. Private Infrastructure – 2.4%
11. Private Credit – 4.4%

As a reference the allocation in 2000 was as follows:

1. US Equities -56.2%
2. International Equities – 14.9%
3. Fixed Income – Structured – 24.8%
4. Fixed Income – High Yield – 4.0%
5. Private Equity – 0.1%

The NYCERS Annual Finacial Statement

Each year, NYCERS issues a financial statement which includes accounting statements and investments results and costs. In particular, the report posts the rate of return for the entire portfolio and each allocation class. Also posted are the investment expenses for the year.

Rate of Return

In the first table below , “Rate of Return” , there is a list covering 1998 to 2023 of

• rates of return (ROR) for the full NYCERS portfolio and
• the ROR for the two classes, 1) US Equities and 2) Fixed Income – Structure.

You will see that since 2002 the average portfolio ROR is 7.13% (22 years), while the average ROR for the two classes, US Equities and Fixed Income – Structured with a 67%/33% allocation is 7.73% over the same 22 years. So how would this difference translate into a change in the NYCERS annual closing balances? I will try to give you an estimate below.

Notes:

• In 2007, both private equity and investment expenses started a steady long term increase.
• In 2015, NYCERS started to report asset rate of returns net of fees. Prior to that returns were reported gross of fees which inflated returns.

Closing Balances

In the second table below, “Closing Balance for NYCERS”, you will see that

• the closing balances for 2001 at $37.30 billion and
• the closing balance for 2023 at $81.4 billion.

That is an average increase of 4.11% over 22 years. This is less than the average portfolio ROR, 7.13%, because each year a part of portfolio return is used to pay benefits and expenses for that year.

You will also see in this table the investment expenses over the 25 years from 1999 to 2023.

Simulated Closing Balances

In order to gauge the effect of using the simple two class asset allocation, I simulated the closing balances from 2002 to 2023 using the two-class investment strategy, I used the closing balance for 2001, $37.3 billion, as the starting base and created the simulated closing balances for each year as follows (see Closing Balance table below):

• for each year I added the ROR for the actual closing balance to the annual delta created by subtracting the portfolio ROR from the ROR of the two-class strategy and
• then multiplying the previous simulated closing balance by the sum of the two percentages plus one to arrive at the simulated closing balance for that year.

In the early years, the portfolio allocation kept ahead of the two-class strategy but by 2013 the portfolio strategy started to steadily fall behind the two-class strategy. By 2023 the closing balance of the two- class strategy was at $91.59 billion while the portfolio closing balance was only at $81.4 billion. Remember that 2015 is the year that NYCERS stared reporting ROR net of fees.

It is reasonable to suspect that the difference between the two strategies may be greater than the $10 billion.

Private Equity and Real Estate LLC's

As of 2007, you will see in the Rate of Return table that the amount of money being allocated to private equity (2018 - real estae LLC) started to grow significantly. The private equity and real estate classes are very expensive. There is also an issue with their assigned values in the actual NYCERS closing balances. The quoted values of these two assets are very unreliable because there are no public markets for these asset classes. The two-class strategy, however, does not have this problem because they both have public markets trading their assets.

Investment Expenses

Finally, if you focus on the investment expense over the 2002 to 2023 period in the Claoing Balance table, you will see that NYCERS paid a total of $3.9 billion of which $2.0 billion was incurred in the last eight years. My conservative projection of the investment expense for the same period using only the two classes is $1.3 billion, a $2.6 billion difference. I based my estimate on the 2002 ratio of investment expenses to the closing balance, 1.14%. >

NYCERS Rate of Return from 2002 to 2023

Fiscal Year	Total Portfolio ROR	Eq - FI only ROR (67%/33%)	US Equity ROR	Struct F.I. ROR	Private Equity ROR	Real Estate ROR	PE assets (in billions)	RE assets (in billions)
2023	8.18%	11.88%	18.07%	-0.68%	0.50%	-1.85%	$8.427	$5.865
2022	-8.39%	-12.62%	-13.64%	-10.56%	25.02%	29.56%	$7.986	$5.672
2021	26.63%	30.21%	45.14%	-0.09%	49.61%	7.75%	$6.422	$4.360
2020	3.58%	6.92%	4.25%	12.34%	1.83%	1.81%	$4.661	$3.802
2019	7.13%	8.40%	8.37%	8.45%	14.66%	8.47%	$4.657	$3.565
2018	8.56%	9.74%	14.71%	-0.34%	17.83%	12.19%	$4.467	$3.398
2017	12.99%	12.23%	18.09%	0.34%	16.45%	10.24%	$9.259	nr
2016	1.52%	3.29%	1.68%	6.56%	6.36%	12.95%	$9.873	nr
2015	3.11%	4.87%	6.35%	1.88%	12.24%	16.06%	$9.825	nr
2014	17.04%	18.90%	24.96%	6.61%	15.20%	13.20%	$9.630	nr
2013	12.24%	15.35%	22.75%	0.33%	8.38%	12.89%	$8.255	nr
2012	1.32%	4.54%	2.23%	9.24%	7.50%	0.99%	$6.748	nr
2011	23.12%	23.55%	32.50%	5.37%	nr	nr	$5.257	nr
2010	14.09%	15.41%	16.33%	13.54%	nr	nr	$4.123	nr
2009	-18.18%	-15.62%	-26.16%	5.78%	nr	nr	$3.263	nr
2008	-4.60%	-6.31%	-12.84%	6.94%	nr	nr	$2.885	nr
2007	18.39%	15.58%	20.02%	6.58%	nr	nr	$1.834	nr
2006	9.83%	5.98%	9.45%	-1.07%	nr	nr	$0.846	nr
2005	9.22%	8.01%	7.91%	8.21%	nr	nr	$0.536	nr
2004	16.03%	13.98%	20.45%	0.83%	nr	nr	$0.286	nr
2003	3.94%	4.45%	0.72%	12.02%	nr	nr	$0.155	nr
2002	-8.64%	-8.64%	-17.05%	8.42%	nr	nr	$0.098	nr
2002-2023 Average	7.14%	7.73%	9.29%	4.58%	14.63%	10.36%
2001	na	na	na	na	na	na	na	nr
2000	9.43%	7.58%	9.06%	4.57%	nr	nr	$0.036	nr
1999	13.47%	13.97%	19.80%	2.12%	nr	nr	$0.000	nr
1998	21.29%	23.21%	28.55%	12.38%	nr	nr	$0.00	nr
Average	8.34%	9.62%
1998-2023 Average	8.04%	8.59%

Closing Balances of NYCERS Assets from 1999 to 2023

Fiscal Year	Invest Fees (millions)	Simple invest fees (millions)	Close Bal (billions)	CB % change	Delta - Portfolio vs Eq&FI only	Improved % Change	Simulated Close Bal (billions)
2023	$489.90	$93.39	$81.40	5.03%	3.70%	8.73%	$91.59
2022	$319.20	$88.92	$77.50	-9.78%	-4.23%	-14.01%	$84.23
2021	$313.20	$98.56	$85.90	22.89%	3.58%	26.47%	$97.96
2020	$245.70	$80.20	$69.90	2.04%	3.34%	5.38%	$77.45
2019	$240.50	$78.59	$68.50	5.06%	1.27%	6.33%	$73.50
2018	$241.80	$74.81	$65.20	6.36%	1.18%	7.55%	$81.77
2017	$223.80	$70.33	$61.30	10.45%	-0.76%	9.69%	$69.12
2016	$213.00	$63.68	$55.50	1.09%	1.77%	2.86%	$64.27
2015	$231.80	$62.99	$54.90	1.29%	1.76%	3.06%	$58.59
2014	$184.60	$62.19	$54.20	14.83%	1.86%	16.70%	$55.27
2013	$183.30	$54.15	$47.20	10.54%	3.11%	13.65%	$47.37
2012	$129.50	$48.99	$42.70	0.71%	3.22%	3.93%	$41.68
2011	$145.10	$48.65	$42.40	19.77%	0.43%	20.20%	$40.10
2010	$175.30	$40.62	$35.40	10.97%	1.32%	12.29%	$33.36
2009	$138.20	$36.60	$31.90	-19.65%	2.56%	-17.09%	$29.71
2008	$115.30	$45.55	$39.70	-6.59%	-1.35%	-7.94%	$35.83
2007	$98.10	$48.76	$42.50	13.94%	-2.81%	11.14%	$38.92
2006	$69.40	$42.80	$37.30	5.07%	-3.85%	1.22%	$35.02
2005	$53.90	$40.73	$35.50	3.80%	-1.21%	2.59%	$34.60
2004	$42.97	$39.24	$34.20	8.57%	-2.05%	6.52%	$33.73
2003	$29.27	$36.14	$31.50	-3.96%	0.51%	-3.45%	$31.67
2002	$37.63	$37.63	$32.80	-12.06%	0.00%	-12.07%	$32.80
Expense Ratio 20202		114.7%
2002 up Avg				4.11%		5.48%
2001	$41.30		$37.30	-12.85%	$37.30
2000	$37.43		$42.80	2.15%	-1.85%
1999	$25.16		$41.90	1.92%	0.50%
1998	na	na	na	na
Total Expenses 2002-2023	$3,921.48	$1,293.52
Diff in Expenses		$2,627.96

NYCERS Profit from 2016 to 2020

Recap

Every year the Comptroller reports on a quarterly basis the rate of return for the NYCERS portfolio. NYCERS’s fiscal year ends on June 30 each year.

Based on the Comptroller’s figures NYCERS has averaged 6.78 % (net of fess) over the last five years. Part of this figure, 2.96%, is created by an inflow of $8.928B in dividends and interest received during the five years.

The rest of the return is created by an increase in the value of the portfolio. The June 30 value of NYCERS’s assets was $69.910B. The starting value in 2016 was $54.289B. That is a 28% increase over the five years. As reference the S&P 500 Index increased from 2063.11 to 3100.29, a 50% increase. 6.78% may seem like an acceptable figure. But what if you could easily increase that return, safely and at a lower cost. There has, unfortunately, never been any comparative analysis of NYCERS’s investment strategy to determine its relative efficiency.

A Better Way

Out of the 40 sub classes of NYCERS's investment strategies, some combination of classes can consistently produce a better long-term return than 6.78%. The NYCERS Russell 1000 Index (stocks) managers have averaged 9.83% (net of fees) over the last five years. The June 30 value of this class was $19.256B

The NYCERS Structure Fixed Income (bonds) managers have averaged 5.47% (net of fees) over the last five years. The June 30 value of this class was $13.427B.

If you calculate a 60/40 stock/bond return using these figures, you will arrive at an 8.09% average rate of return over the last five years. These two classes generate the bulk of the dividends and interest received by NYCERS during the year.

Another aspect of using only this combined class strategy is that you would save at least $750M in fees over the five years.

Fantasy Island

There are three of NYCERS's sub classes of investment strategies, private equities, real estate, infrastructure, that are highly questionable.

The Comptroller has reported the total value of these classes to be $9.272B as of June 30, 2020. That is 13.45% of the total $68.91B NYCERS portfolio. The $9.272B amount is not verifiable, just a guess.

He quoted the 5-year average rate of return for these classes (gross of fees) as: 9.56% (PE), 11.07% (RE), and 11.93% (IF). These rates of return are also not verifiable, just guesses.

These investments do not pay dividends nor interest and incur most of the $750M in fees that would be saved with the two-class strategy. There is, however, a constant flow with these investments, cash going out and cash coming in. Unfortunately, this flow is not reported in the financial statements. I suspect if this cash flow were reported for the last 23 years, there would be changes in the law governing the allowable investments for the city’s pension investments.

Strange Accounting at the CO-VSF and NYCERS

There appears to be some strange entries in the CO-VSF financial statements (City CAFR's) over the last several years.

• In the fiscal year ending June 30, 2014 there is an entry for $38M for benefit payments. There wer was no VSF benefit payments in December, 2013. There was also an entry for $190M for a skim from NYCERS to CO-VSF. The year opened with a balance of $36M and closed with a balance of $188M
• In the fiscal year ending June 30, 2015 there is an entry for $78M for benefit payments. The skim entry was $30M. The year closed at $140M.
• In the fiscal year ending June 30, 2016 there is an entry for $82M for benefit payments. The skim entry was -$53M. The year closed at $5M.

In May, 2015 NYCERS appointed a new actuary, Ms. Sherry Chan. The NYCERS actuary is also the CO-VSF actuary. The NYCERS chair and the Comptroller are also trustees of the CO-VSF Board.

In a May 12, 2016 resolution the NYCERS Board and the NYCERS actuary stated that there was a mistake in FY-2014 skim. The skim should have been only $137M and not $190M. In response to this screw up NYCERS pulled $53M out of the CO-VSF.

It is not clear wheteher the -$53M entry was just an accounting correction or an actual movement of money from CO-VSF to NYCERS. I do not know whether there is any legal authority that allows money to flow back to NYCERS from the CO-VSF.

In a Nov. 4, 2016 letter to the CO-VSF Board the NYCERS actuary, Ms. Chan, states on page 3 that there will be no skim in FY-2017 into the CO-VSF.

The actuary states that the skim is based whether the FY-2016 return on NYCERS's equity investments exceeds the average yield on the 10 year U.S. Treasury Notes by 115%.

She does not define what are NYCERS equity investments nor does she describe how she computes the returns. In particular she does not state whether hedge funds, or private equity and real estate partnerships are included in the equity investment class and how she would compute their returns considering that they are illiquid. For the record she does not state specifically what was NYCERS's return on its equity investments in FY-2016. She does not state what was the average yield on the 10 year U.S. Treasury Notes or how that number was computed.

If there is no skim, then there was a deficit for the CO-VSF for FY-2016. She does not mention what that resulting deficit was. There should be running chart year by year showing what the excess or deficit is and what the skim hurdle is.

She also states that the market value of the CO-VSF assets as of June 30, 2016 is $47M. She provides no details or support for this statement. The city CAFR states that the June 30, 2016 CO-VSF closing balance was $5M. For the record the city CAFR also does not detail the CO-VSF assets.

As far as I know there is no documentation about the investment activity for the CO-VSF. With a 3% return rate interest rate on a $35M bond portfolio, you should expect a $1.5M interest flow each year into the fund. The reported interest earned was $184,000 in 2016, $10,000 in 2015, $20,00 in 2014, and $38,000 in 2013. There is something very strange going on.

Investment Fees for NYC Pension Funds since 2000 - Good Work If You Can Get It

The Comptroller just came out with the city's financial statement on Halloween. One of the interesting items in the report is the amount paid in investment fees for the five city pension funds. FY-2015 continued the insane upward trend as you can see from the list below. The grand total for the last 15 years is $4.0B. Yes, that is billion. All for 3.6% rate of return, maybe.

1. 2014 - $530.2M
2. 2013 - $472.5M
3. 2012 - $370.3M
4. 2011 - $395.7M
5. 2010 - $426.8M
6. 2009 - $339.3M
7. 2008 - $310.2M
8. 2007 - $262.0M
9. 2006 - $192.7M
10. 2005 - $158.2M
11. 2004 - $131.6M
12. 2003 - $ 96.7M
13. 2002 - $101.9M
14. 2001 - $100.0M
15. 2000 - $100.0M

It's not just New York City!

It is not just the NYC pension funds that have lost their way with alternative investments. It has spread throughout the country as you can see from this story about North Carolina.

State Insurance Audit Checklist

Since July 29. 2013 the State Insurance Department (NYS DFS) has accessed my blog 29 times. So I thought I would provide them with a suggested reading list. Below is a starting list. If I see something else that looks interesting, I'll add to the list.

• Who got the $140M?
• Why was the Transit Operating Force death benefit changed?
• The former chair of the NYCERS Board of Trustees
• Why is NYCERS paying the Comptroller?
• The civil service qualifications for the current NYCERS executive director
• Unaccounted investment fees , background , and more
• Investment madness
• Lack of disclosure on private equity and real estate transactions
• Hedge funds
• Private equity managers
• Delays in processing loans
• Examples of SPD errors ( A , B )
• NYCERS perjury
• D.O.I. and the perjury charge
• Funny wrinkle to the perjury and corruption story
• The WC offset nightmare
• Denial of due process
• The assumed interest rate
• Finally 7%, sort of
• Delays in pension benefit revisions
• The Met-Life building
• Disaster recovery site at L.I.C.
• Allegra Capital and lack of accounting oversight
• Harassment of EMS disabled retirees, and more
• Outside legal services
• Background on past State Insurance Department reports

Teachers Retirement System - Why is it $4.4B short

I recently became aware that the NYC Teachers Retirement System (TRS) has had a regular and significant negative cash flow as far back as 2000 and maybe further. The total negative cash flow for the 13 years is $8.8B . In plain English a negative cash flow for a city pension fund means that the employee and employer contributions, interest payments, and dividends are less than expenses and pension payments. That leads to liquidating assets to cover the shortfall and creates a permanent handicap when it comes to investment returns.

This raises a question about the actuary's funding strategy for TRS.

None of the other four city pension funds have had consistent negative cash flows over the same time period. As of June, 2012 these four funds have reached or surpassed their pre-crash 2007 values. From the table below you can see that TRS is $4.4B short of its 2007 asset value.

TRS has a serious investment problem. Of course, in FY-2012 the other four funds didn't do so well with their positive cash flows. The five funds managed to turn $1.45B into $306.5M in a market that was was up 3.4% for the year.

The New York State Department of Financial Services (DFS) has not done a statutory examination report on any of the five city pension funds since at least 2003. This is in spite of the fact that the pension funds have paid DFS for the associated audits.

Asset Values and Cash Flows for the Five City Pension Funds: (2007 - 2012)

Pension Fund	2007	2009	2012	2012	2012
	Closing Balance	Closing Balance	Closing Blanace	Asset Change	Net Cash Flow
NYCERS	$42,514.3M	$31,903.4M	$42,655.3M	$246.3M	$728.0M
TRS	$37,142.8M	$23,077.5M	$32,774.8M	-$826.7M	-$472.3M
BERS	$2,179.5M	$1,536.6M	$2,310.6M	-$13.0M	-$46.4M
Police Fund	$21,905.5M	$17,424.1M	$25,479.9M	$731.0M	$944.0M
Fire Fund	$7,202.7M	$5,576.8M	$8,124.7M	$169.0M	$268.0M
Total	$110,944.7M	$79,518.3M	$111,345.3M	$306.5M	$1,452.4M

NY Times - David Chen - Bloomberg - Investments

On February 16, 2013 David Chen wrote an article in the NY Times about the NYC Teachers' Retirement System decision to divest itself of any investments in five gun companies.

The catch to the story was that the vote was 4 to 1. The opposition vote came from the a trustee appointed by the mayor.

Mr. Chen went on to state in his article that

"The mayor has long recused himself from any pension decisions because his company, Bloomberg L.P., does business with all the pension funds, his aides noted."

After over 11+ years in office this is the first time I have heard that mayor has had a long held policy of recusing himself from pension decisions.

Bloomberg L.P. does not do business with NYCERS and I suspect that is true for the other four city pension funds.

While the mayor is not a trustee of any of the five funds, his appointed representative at NYCERS has consistently voted on all resolutions voted on by the Board of Trustees. Again I suspect that is true at the other four funds.

My point is that Mr. Chen needs to do a little more homework when dealing with the mayor's office and pension issues.

It is ironic that Mayor Bloomberg's fortune has grown so well over the last 11+ years, while the city pension funds have struggled during his tenure in office.

Mayor Bloomberg and the NYCERS Trustees

The structure of the NYCERS Board of Trustees is defined by Section 13-103 of the NYC Admin Code.

The Trustees are:

1. the Mayor's representative who is the chairperson,
2. the Comptroller,
3. the Public Advocate,
4. the five Borough Presidents, and
5. the chief executive officer of each of the three employee organizations who represent the largest number of employees who are members of NYCERS.

Up until 2009 there was no problem with this composition of the Board. But when Martha Stark was shunted over to CUNY from Finance, some brilliant staffer in City Hall decided to make the mayor the chairperson of the Board.

In his most recent written designation of his representative the mayor uses the following wording:

Prusuant to New York City Administrative Code Section 13-103, I hereby designate Ms. Carolyn Wolpert, as my representative to exercise the discretionary powers and duties granted to me as Chairperson of the Board of Trustees of the New York City Employees' Retirement System Pension Fund and related variable supplement funds. Janice Emery, Elizabeth Botwin, David Frankel, John Grathwol, Omair Hassan, Raymond Sarola and Justin Holt, in that order, will serve as my alternate representatives in Ms. Wolpert's absence.

Just for contrast here are the exact words from Section 13-103:

1. A representative of the mayor who shall be appointed by the mayor and who shall be entitled to cast one vote. The mayor, by a written authorization filed with the board, may designate one or more members of his or her office to act in the place of such representative, in the event of his or her absence. Such representative or designee acting in his or her place shall be chairperson of the board.

For the record the world won't come to an end because of this botched designation.

But what it does show is a flawed attitude towards NYCERS by City Hall. First of all the mayor has no discretionary powers and duties granted to him as the Chairperson of the NYCERS Board. He is not the Chairperson of the NYCERS Board. He is not even a trustee of the NYCERS Board. In fact I think it is correct to say that the trustees do not have discretionary powers but are strictly bound by statutory and fiduciary obligations.

Why can't the mayor just designate a representative to the NYCERS Board and leave the misplaced sense of power at home. He should focus on the quality of his representative to the NYCERS Board. Some of his past choices have been very questionable.

Yesterday the mayor presented his FY-2014 budget. It had an $8,076(MM) pension cost for the five city actuarial pension funds.

Part of that cost was $357(MM) for investment expenses incurred in FY-2012 plus two years of 7% interest charges. You can reference the investment expenses in the FY-2012 CAFR on page 162 and while you're there look at pages 115 and 121. The five funds earned a miserable 1.4% on their assets in FY-2012 but the investment managers were well paid.

I wonder whether the mayor would be satisfied paying that kind of money for that kind of result on his assets?

NYCERS Investment History: 2002 – 2009

In light of the recent negative investigative findings by DOI of the former NYCERS Chair of the Board of Trustees, it would be prudent for the trustees to review the investment decisions that occurred during her tenure from 2002 to 2009.

As background, DOI found that the Chair failed to implement corrective actions with respect to the city’s property valuation system. Such actions were agreed upon by all parties in response to a major 2002 bribery scandal in the property valuation system. The Chair subsequently lied about implementing these actions. During this seven year period NYCERS’s started making significant real estate investments, as outlined below.

In addition, there is an alleged claim of interference by the Chair in the property valuation of the Met-Life Building just prior to its 2005 sale for $1.74B to a limited partnership which included both NYCERS and NYCTRS. The NYCERS Chair was also the Chair at NYCTRS at the time. This allegation was reported to the Manhattan DA’s office in 2006 but no action was taken. The new DOI report should prod the DA to wake up.

Considering the huge increase in private equity investments during the same period along with the associated scandal at the NYSLERS pension fund in Albany, the trustees should expand their review to this asset class also.

To complete their due diligence the Trustees should review the unresolved perjury and conspiracy charges still pending against senior NYCERS management.

As of June 30, 2002 the assets of NYCERS were reported to be worth $32.2B with no real estate investments and $96M in private equity.

As of June 30, 2009 the assets of NYCERS were reported to be worth $30.9B with $885M in real estate investments and $1.9B in private equity.

"Public Pension Suckers for Private Equity"

Please read this February 16, 2012 Forbes article by Edward Siedle.

Then read some of my prior postings on private equity investing: hard reality, zombie funds, and make sense.

Investment History at NYCERS - The good old days

Listed in the chart below are the values of the NYCERS portfolio for the last 30 years (as of June 30).

In the 1980's NYCERS tripled the value of is assets.

In the 1990's NYCERS more than doubled the value of its assets.

In the last ten years, instead of increasing its asset value, NYCERS has lost $8B or 20% of the value of its assets.

What makes this downward trend worse is that in FY-92, for example, NYCERS spent $13M in investment fees. While in FY-2010, NYCERS spent approximately $150M in investment fees. There is no accountability for the investment decisions of the trustees. No one knows whether they are brilliant or incompetent.

The next time you hear someone attack public pension plans, point out to them that investment decisions by elected officials are the main threat to the solvency of the pensions. By the way you never hear of workers not making their pension contributions. That skill is left to employers, both public and private.

Year	Value	Year	Value	Year	Value
1981	$5.541B	1991	$18.852B	2001	$37.519B
1982	$5.867B	1992	$20.670B	2002	$32.212B
1983	n/a	1993	$22.939B	2003	$30.841B
1984	$8.014B	1994	$22.432B	2004	$33.526B
1985	$10.178B	1995	$25.455B	2005	$34.703B
1986	$12.534B	1996	$27.984B	2006	$36.650B
1987	$13,866B	1997	$32.439B	2007	$42.237B
1988	$14.349B	1998	$37.463B	2008	$38.862B
1989	$16.499B	1999	$41.024B	2009	$30.929B
1990	$17.904B	2000	$42.997B	2010	$34.618B

Is AG Cuomo investigating NYCERS?

On February 8, 2010, Attorney General announced agreements with Markstone Capital Group and Wetherly Capital Group and its broker/dealer DAV/Wetherly Financial to resolve their roles in Cuomo’s investigation into pay-to-play practices involving the NYS Common Retirement Fund (CRF). Markstone agreed to return $18M to CRF and Wetherly agreed to return $1M to CRF. Wetherly also agreed to exit the placement agent business.

Wetherly represented three private equity firms before CRF. They were Ares, Freeman Spogli, and Levine Leichtman. Wetherly was paid fees by these firms and then split the fees with Henry “Hank” Morris. NYCERS also has contracts with these three firms as well as Markstone.

In 2005, NYCERS entered into a contract with Paladin Homeland Security, another private equity firm and as of September 30, 2005 has invested $17.83M with Paladin under two different contracts. Actually, the Comptroller negotiated and signed the contract for NYCERS. The trustees are unaware of the terms and conditions of the contract. This is true of all investment contracts that the Comptroller arranges for NYCERS. Other NYC pension funds also have invested funds with Paladin.

From inception till June 30, 2009 NYCERS has paid Paladin $3.5M in fees for both partnerships. NYCERS has scheduled $837,000 for FY-2010 in fees for Paladin.

In fact, the Comptroller directly paid these fees to Paladin. NYCERS has surrendered control of payment of investment fees to the Comptroller. This means NYCERS never knows what is actually being paid by the Comptroller. The fund also does not know when the fees are paid or how they are paid.

This is in clear violation of Section 13-137 of the NYC Administrative Code.

§ 13-137 Payments from funds. All payments from such funds shall be made by such comptroller upon a voucher signed by the executive director of the retirement system.

In 1996, I had a fight with Comptroller Hevesi’s office over his attempt to short circuit this statutory requirement. For some reason the NYC Law Department folded and stated that NYCERS could violate this state law. For the record, this statute mimics the standard accounting practice of two person control, a bedrock of fraud control in any organization.

Here is the punch line. Between 2005 and 2007, Paladin paid $931,236 to DAV/Wetherly. Paladin paid this amount in return for “services” rendered in association with investments made by the NYC pension funds with Paladin. This information was included in a report prepared by Paladin and submitted to CALPERS as part of CALPERS effort at full disclosure of third party activity surrounding CALPERS investments.

Who's Minding the Store: Paying $143M to lose $7.8B.

Review of NYCERS Investments for FY-2009: $7.8B loss and $143M fees

On December 31, 2009, NYCERS submitted its FY-2009 financial report (CAFR) to the national government finance association (GFOA) in Chicago.

The bottom line on NYCERS income statement showed a loss of $7.8B. That is a 19.6% loss in assets ($31.9B down from $39.7B).

For this disaster, NYCERS paid $143M in investment fees and expenses. The city and other participating employers must replace the $143M with 8% interest in FY-2010. As a reference, NYCERS paid $45M in investment expenses in FY-2003. This cost explosion is a recent development.

You can see a breakdown on the specific investment classes on a chart that I recently posted. It outlines each class’s performance and expenses for FY-2009.

As listed in the chart there are 23 asset classes. This strategy is much too fragmented and expensive for any pension plan and far too risky for a pension plan that has an annual benefit payout obligation equal to 11% of assets ($3.3B benefits, $31.9B assets).

On the rational side of this strategy, there are six of the classes with assets of $17.1B and annual expenses of $4.6M.

On the truly out of control side of this strategy, there are two classes with assets of $2.7B and annual costs of $99.7M.

It is clear to me 1) that the six classes are totally sufficient for NYCERS investment needs, 2) that NYCERS would save well over $120M per year in fees using only the six classes, and 3) that the six classes would produce a higher rate of return than the 23 class scheme.

Unfortunately, even if sanity would return to the trustees, the Comptroller's office has signed contracts that require NYCERS to submit to this legal rape and pillage. The best NYCERS could do is to stop the bleeding and drop whatever contracts that have an opt-out clause.

The trustees also need to change the investment consultant function. They need to hire a totally independent advisor with no income coming from investment managers. The consultant must commit significantly more resources to assist the trustees. The consultant must have a permanent presence at the NYCERS site so that he/she can perform comprehensive analysis of manager’s performance and be available to all trustees on daily basis.

This consulting function would most likely cost about $10M a year. It is, however, far better to have the consultant earn his/her profit from NYCERS rather than from the managers that he/she is suppose to audit and monitor.

The following are comments about specific asset classes

US Stocks

The work horse of the NYCERS portfolio is the indexed domestic stock class. Its value on June 30, 2009 was $10.0B, 31% of the total portfolio. Last year was a disaster with a -26.44% loss in this class. This class, however, always has the saving grace of having almost no cost. The 2009 fees were only 0.3 basis point of assets managed. Yes, that is less than one basis point. The annual return over the last 15 years is 6.98%.

Comment on reported returns: The Comptroller, on a quarterly basis, reports rates of return for individual managers. He/she provides no data or calculations to support the accuracy of these rates of returns.

In contrast, NYCERS actively managed domestic stock class had a -25.11% return before fees were paid. The 2009 fees were 24.0 basis points. The annual return, however, over the last 15 year is 6.26%, gross of fees. This class is a waste of time and very expensive. Pension funds should not be involved with this asset class. This is a touchy subject because of industry wide implications of this position.

A particularly questionable asset class is the domestic stocks - minority managers class. This class had a return of -27.66%. This performance is worse than other active managers. The 2009 fees for this class were 68.8 basis points. Any attempt to provide opportunities to minority managers legally should not cause any increased expense to NYCERS. This asset class borders on gross negligence by the trustees. The NYC Law Department has failed to properly advise their clients of their fiduciary obligations.

Minority managers also appear in the bond and international stock classes. The comments made above are also relevant in these two other classes

International Stocks

Actively managed international stocks had a return of -32.2% last year, gross of fees. The 2009 fees were 32.6 basis points. This class has had extensive turnover the last three years reflecting the risk in this area. It also has the same performance flaw as the actively managed domestic stock class. International stock exposure should be handled on a country structured indexed basis.

NYCERS indexed international stock manager had a return of -30.68% last year, gross of fees. The 2009 fees were 1.7 basis points. This class needs to be broken down to a country grouping. As an example, Japan has a heavy weight in this index and has pulled down the index’s performance.

The emerging market stock class had a return of -31.41% in 2009, gross of fees. The fees were 36.9 basis points. This class should also be shifted into the index class. If a country doesn’t have a reasonable index, NYCERS should not be invested in that country.

US Bonds

NYCERS has a long standing effective domestic bond program. Listed below are the four traditional classes with their 2009 returns and fees:

1. investment grade corporate bonds, return = 2.44%, fees = 2.6 basis points

2. government bonds, return = 7.04%, fees = 7.4 basis points

3. mortgage backed bonds, return = 6.26%, fees = 7.0 basis points

4. dollar denominated foreign bonds, return = -5.62%, fees = 7.7 basis points

.

The dollar denominated foreign bond class performed poorly in 2009 but has a good performance history and its fees are comparable to that of domestic corporate bond class.

The high risk domestic bond class had a -1.28% return last year, gross of fees. The fees were 27.9 basis points. The annual return for the last ten years has been 4.88% while the corporate bond return has been 5.58% and has fees in the range of 7.4 basis points. This high risk class just can not compete with high grade corporate bonds.

In 2008, NYCERS began investing in convertible bonds. This class is just inappropriate for a large pension fund which has both equity and fixed income investments. The return was -13.19% and the fees were 39.2 basis points. The high basis point number is a tip off to stupidity.

The actively managed inflation protected government bond (TIPS) class is too expensive when compared to the standard government bond class. The inflation protection is not sufficient to justify this class’s severely discounted rate of return. This also applies to the index TIPS class.

Unregistered Investments

At the end of the list of investment classes are two classes that have gotten completely out of control. They are private equity and real estate partnerships. Both classes are illiquid and have no published market value.

The fees for private equity were $81.7M and for real estate were $15.3M. The consulting fees for these two classes were $2.7M

This is 70% of the total annual investment expenses for the entire portfolio but the asset classes have a book value of only $2.7B or 8.8% of the portfolio. The private equity class has 116 partnerships. NYCERS did not report fees paid for 26 of them. The real estate class has 30 partnerships. NYCERS did not report fees for 8 of them. This is a sign of NYCERS's lack of financial control over the payment of fees to all managers. What is particularly questionable about these two classes is that $25M of the $99.7M is classified as organizational costs. That means NYCERS is not reporting who or why this money was paid. There is a high potential for fraud when controls are not present.

While NYCERS does not report rates of return on either of these classes, the real estate class dropped in value from $1.2B to $.886B in FY-2009.

Conclusion

In hind sight, it is always easy to criticize. The trustees’ investment decisions over the last ten years, however, have been purposely aggressive. This was done in the hope of keeping employer contributions lower than they would have been if the trustees had followed a more conservative strategy. It is perverse that, overall, the conservative strategy would have been less expensive for the employers. This is the price of incompetence.

While there is a growing funding problem at NYCERS (it is much worse at the other four city systems) caused partly by benefit enhancements that were enacted in 2000, the main source of this problem is the underfunding by participating employers and the investment failures by the NYCERS trustees.

I will not even comment on the campaign contribution issue.

Shake Hands with the Devil

In early 2000 at the height of the dot-com bubble, the former mayor agreed to major improvements in the pension benefits for city workers. At the same time, the trustees of the five city pension funds agreed to a “market restart” of the assets of the city’s five pension funds as recommended by the NYCERS & TRS actuary. This allowed the city to drastically cut its pension contributions in 2000.

But almost immediately, the devil came knocking on the door. After steadily advancing for ten years, the market perversely began to collapse and did not recover until 2003. See note below.

In the summer of 2002, it was clear to informed experts that the five city pension funds were headed in the wrong direction and that they needed to make serious changes to the systems. They, first, had to put in place a lower benefit structure for new employees. Second, they had to significantly increase employer contributions. Third, they had to put in place an investment strategy that would minimize risk, steadily grow the assets of the funds and produce an adequate and reliable income stream. For various reasons they did none of these things.

Then in 2007, the mortgage crisis hit and the devil was back with a vengeance. When the markets closed on June 30, 2009, the city pension funds had approximately $82B in assets, $19B less than they had 10 years ago. The rate of inflation over the last ten years makes this loss even worse than it first appears.

Over the same ten years, the pension funds have fallen short of their expected rate of return by $53B. The actuary’s 8% target has turned out to be beyond the reach of the trustees. Perversely, it also caused the trustees to adopt a very aggressive investment strategy.

Since the City Charter revision in 1989, the mayor has become the dominant political figure in the city. As such, his representatives on the pension boards wield tremendous power. It is unfortunate that his former choice for the NYCERS and TRS chairperson brought no expertise to this position. In FY-2009, the trustees of the five pension funds blindly spent $400M on investment fees while the funds lost $19B in assets.

It is ironic that in the midst of theses losses NYCERS earns a guaranteed 7% rate of return on loans to NYCERS members.

While the assets have been shrinking, the benefits have been exploding. In 2009, the five pension funds will pay out $9.9B. This is an 80% increase from the $5.5B pay out in 2000.

The city’s budgeted pension contribution for 2010 is $6.4B (with a phantom $200M projected savings). That is 17.5% of the total city payroll. While this amount is obscenely out of proportion to the payroll, it is significantly short of what is needed to properly fund the current pension benefits. In fact, the city’s contribution to the FDNY pension fund is $874M, well over 80% of the firefighters’ payroll. In FY-2008, however, this retirement system was only 56% funded.

In addition to the city’s contributions, the city’s 240,000 workers will be required to contribute over $755M to the pension funds in 2010.

On July 1, 2009, the governor signed the extension bill for Tier 3 &4. Because of his previous veto of the police & fire Tier 2 extension bill, all new police officers and firefighters are in Tier 3. While this 33 year old law has never been analyzed for police & fire benefits, it is reasonable to assume these benefits are less costly than the Tier 2 benefits.

This sets the stage for a rewrite of pension benefits for all new NYS employees. While employees are entitled to decent retirement benefits, employees will be at risk, if those benefits are not sustainable.

If new employees benefits are reduced, then future investment policy must be based on a conservative, highly transparent strategy with minimal management costs.

In addition, there can be no campaign contributions allowed at any time from any firm or their employees & spouses, who have contracts with the pension firms, to any person who makes decisions effecting those contracts. Without this change, the investment process will continue to rot.

Also as part of the reform, there is a need for a mandatory minimum/maximum contribution by the city and participating employers. If the employees are required to pay 3% of their pay checks, then the city should always pay at least 6% and cap its upper liability at 10% for new employees and new benefits. This would be a big incentive to keep the investment strategy conservative and not let the benefit structure get out of hand.

Funding a pension system is a simple process and if done with integrity, almost never fails. If you consistently contribute 12% of income to a fund and invest the money wisely, in 30 years with a 6% percent rate of return, you have a 50% pension at age 62. Why do some many pension funds fail? Without effective oversight, people tend to stray. It is telling that the NY State Insurance Department has not issued an audit of any of the city pension funds since 1999. On June 25, 2009 the Insurance Department finally issued the audit for NYCERS covering FY-2000 to FY-2002. Better late than never.

There is now a real danger to the pension benefits of city workers and retirees. Underfunding, bad investment decisions, and excessive benefits are the death kneel for a pension fund.

Note: From 1989 to 1999, the NYCERS assets rose from $16.5B to $41.0B. From 1999 to 2009, those same assets fell from $41.0B to $29.8B and the funded status has dropped from 136%. to 80%.

No Oversight for Payment of Investment Expenses

Payment of funds from NYCERS is controlled by Section 13-137 of the NYC Administrative Code. Simply stated, the NYC Comptroller is authorized to make payments from NYCERS assets based on written authorization from the NYCERS executive director. Not only is this the law but it is sound accounting practice. It is called "two man" control, excuse the old sexist term. It is much harder to steal when there are two independent parties involved.

In 1996, the former NYC Comptroller, Alan Hevesi, convinced the NYC Law Department and the NYCERS trustees to allow him to pay NYCERS investment expenses without the inconvenience of getting written authorization from the executive director. Needless to say the executive director pointed out the violation of law to the interested parties but to no avail. The NYC Law Department has the final say on legal interpretations. The executive director could have filed an Article 78 action but he would have had a hard time paying the legal costs since he would no longer have been the executive director.

The NYC Comptroller is the official auditor for the city and specifically for NYCERS (Section 13-103.g). With this in mind, we should focus on the fact the auditor for NYCERS is free to make payments to outside vendors without an oversight from NYCERS. We have Alan Hevesi to thank for this truly ludicrous situation.

This situation has become more and more dangerous in recent years. NYCERS Investment expenses have been accelerating upwards in the last five years. The 2003 costs were $29M but the 2008 costs were $115M and 2009 will most likely be $150M. What is truly sickening about this is the billions of dollars NYCERS is currently losing with these high expenses.

Asset Allocation Dilemma

NYCERS has an asset target of 30% for its bond investments; 25% for investment grade and 5% for junk bonds. The trustees have invested the rest of the portfolio in various classes of equity; domestic, foreign, private, and real estate.

This aggressive investment strategy was needed to support a projected 8% investment profit target.

This, in turn, allowed the city and the other employers to make lower payments to NYCERS since 2000. It, however, exposed to greater swings, up and down, in its investment returns.

In effect, NYCERS was gambling that it would make a lot of money and the city could save a lot of money. Over the last 9 years has lost that gamble. While it is easy to criticize in hind sight, you can make a good argument that this policy was never prudent in the first place, especially after the 2000-2002 collapse.

If NYCERS had followed a conservative investment strategy, 50% in investment grade bonds,the city would have had to contribute significantly more money since 2000 but it now would have a much smaller burden going forward.

Because of massive equity losses NYCERS now has 36% of its assets in bonds. This will require NYCERS to re-balance under the current asset allocation 6% into a foreign equity position. That is a scary thought.

The NYCERS trustees are faced with the dilemma of either staying with their aggressive strategy or shifting to a more conservative policy. The elected officials and union presidents on the board are highly conflicted. A conservative strategy is most likely what is best for the members and retirees of NYCERS. It definitely is not what is best for the city.

Not only would the city have to cover current losses, it would have put up more money on an ongoing basis in recognition of the fact that a 8% profit target is not prudent and probably never was. Do the trustees take care of politics or the retirees?

Strangely, NYCERS for the first time committed money to convertible bonds in the spring of 2008. They have lost 25% of the $390M invested. Convertible bonds add equity risk and reduce fixed income returns. In this market it was like throwing a match into a gas tank.

Board of Trustees

NYCERS is administered by a board of trustees. There are eleven trustees on the board. Eight are elected city officials and three are presidents of the unions with the largest membership in NYCERS.

The NYC Comptroller and the Public Advocate are trustees, as are the five Borough Presidents. You can see the shadow of the old Board of Estimate in NYCERS’s board. Actually prior to 1968, the Board of Estimate administered the pension system. Interestingly, the mayor is not a trustee but appoints a person to be a trustee. That person is also the statutory chair of the board.

The director of the city’s Office of Labor Relations is required annually to verify the status of the three unions with the largest membership in NYCERS. The director has never performed this annually verification.

DC-37 currently is one of the union trustees on the board. DC-37 has a history of internal widespread corruption which resulted in receivership by the national union, AFSCME, in the late 1990’s.

The trustees are responsible for the investment decisions of pension system.

The Comptroller is the statutory custodian of the assets. Historically this meant that the Comptroller had the actual physical possession of the securities owned by the pension system. Long ago, the Comptroller ceased to be able to be the actual custodian and for many years has contracted out this function to a custodian bank. Currently this bank is the Bank of New York. For many years, it was Citibank.

The trustees are statutorily authorized to delegate their investment authority to the Comptroller. The trustees do this each June for the following 12 months. This delegation has no stated rationale and the Comptroller has no obvious investment expertise. For the sake of obvious prudence the trustees have hired outside experts to advise them on investment decisions and outside managers to actually execute those decisions. Unfortunately, the trustees underpay their investment advisers and overpay their investment managers. This results in questionable advice and overpriced performance.

It is clear to everyone that the trustees have no particular skill in investment matters. The trustees, however, have over the years felt free to claim credit for the investment performance of the assets of the pension system. I wonder if they will feel free to accept blame for that performance.