Mike Nehf's response to Ryan Holderman's 9/30/08 letter re: PBI awards (bonuses) for investment staff

From Ryan Holderman, October 15, 2008
Subject: Mr. Nehf's response to my letter regarding PBIs
Dear One & All:
I have attached the response to my letter regarding the payment of Performance-Based Incentive awards that I recently received from STRS Executive Director, Michael J. Nehf. [Letter published below]
I hope that it helps in understanding why the PBI awards were given at a time when there is so much economic upheaval.
I appreciate the thorough response that Mr. Nehf took the time to provide. He and Dr. Leone were the only respondents to my query. [Ryan's letter was sent to all the Board members.]
Sincerely,
Ryan

[STRS Ohio letterhead]
October 6, 2008

Dear Mr. Holderman:

I appreciate your writing to us with your concerns about the payment of Performance-Based Incentive (PBI) awards to eligible Investment associates, following approval by the Retirement Board at its September meeting.

In your message, you have asked why "bonuses were paid when goals and benchmarks were not met." I am happy to respond through this e-mail; I would also refer you to our August and September 2008 editions of Board News (which were sent out via our e-mail news service and posted on our Web site), where this topic was also discussed.

Contained within the PBI Program, which is reviewed and adopted by the Retirement Board annually, are a number of objective criteria used in the calculation of PBI payments. As you correctly noted in your e-mail and as we shared in our communications to members, not all the goals were met. The total fund return did not exceed its benchmark by 40 net basis points and the total fund return was negative for the year.

You are also correct that the total fund return was -5.44% for the fiscal year 2008 (July 1, 007-June 30, 2008). However, our total fund return (-5.44%) exceeded the composite benchmark return of -5.79%. When markets decline, the value of our investment assets declines. Conversely, when markets go up, the value of our investment assets goes up. Our goal throughout is to minimize losses and maximize returns beyond the markets' performance. In the case of fiscal year 2008, our total fund return beat the composite benchmark return by +.35% The net value added after deducting all direct investment costs was 24 basis points or about $215 million for the year. So, in other words, active management by our STRS Ohio Investment associates and external managers resulted in the total fund return loss being less than it would have been if the assets were passively indexed -- and your pension plan benefited.

In our August Board News, as well as in the October newsletter that you will receive this month, you will see a chart that shows the performance of each asset class against its benchmark, resulting in the net value added of 24 basis points. For example, the benchmark return for fixed income investments was +6.22% for fiscal year 2008. However, the return on our fixed income investments was +6.82%.

In summary, based on the goals that were met, a PBI payment for performance in fiscal year 2008 was made, but because not all goals were met, it was less than the maximum potential amount.

I would also like to add one additional factor into our discussion. We internally manage a significant portion of STRS Ohio's investment assets -- about 80% -- versus using outside money managers. This long-standing practice has saved this system millions of dollars. In calendar year 2007 alone, we saved about $100 million in fees. The total compensation for our Investment associates still places them in the bottom quartile (25%) of total compensation levels in the private market (when 100% of maximum PBI is earned).

As you noted, these are challenging economic times. The value of many Americans' personal investments is declining. It is at times like these that the value of the defined benefit plan you and your retired colleagues have with STRS Ohio becomes even more apparent.

Thank you for giving me an opportunity to respond to your questions. Also, if I may divert from the topic of investments for a moment, I understand that you have been an ardent proponent of our health care legislation. Let me take this moment to thank you for your efforts on this initiative.

Sincerely,

Michael J. Nehf
Executive Director