Rich DeColibus to Mark Meuser: The horse may be gone from the barn, but let's make sure the barn doesn't burn down, too

From Rich DeColibus, April 20, 2009
[Sent to the STRS Board after it was refused by Mark Meuser's mailbox]

Dear Mr. Meuser,

First of all, thank you for the courtesy of a reply. I appreciate your taking the time to respond. I would like to address some of your points and do so with the understanding we're dancing in the gray area of opinion, not the arena of certainty.

Nobody believes it's our Investment Counselors' responsibility that the market tanked big time. We'll attribute that to the Wall Street wizards and banks and rating agencies who collectively created monsters they didn't know how to tame. What is more at issue is simply this: our Investment Counselors did better than the market average, but how much better? Yes, the 0.35 basis points mean something. What is true is STRS trumpets this number as if it majestically huge, while detractors pooh-pooh it as so insignificant it is meaningless. Given our asset amount, it does amount to $215 million, a number large by itself but, when push comes to shove, is about one-third of a percent of our assets. It is, in short, large in isolation and tiny in comparison. To be brutally honest, STRS has fared very poorly in investment competence compared to other Ohio retirement systems, something which certainly undermines the contention having our Investment Counselors "in house" has substantially improved our investment strategy. In the end, the assertions made must be backed up by the facts. To not change direction when the facts no longer sustain a given point of view is intellectually dishonest. "Faith" this is the correct investment strategy belongs to religion and ideology, not finance.

If the truth be known, when the market goes up, STRS's assets will go up in value, and when the market goes down, we will lose assets. The question is can we do better than average no matter how we manage the assets. I have no problem with managing our assets in house as we do, although it would certainly eliminate a lot of controversy if we just used index funds. It would be utterly foolish to use outside investment firms, no argument about that. While you accept the $215 million better-than-the-average as proof positive our Investment Counselors more than earned their salaries and bonuses, I'm not there yet.

The reason is simple: a one-third of a percent better than market index is well within the range of random luck. The market routinely goes up and down several percentage points per day; over the course of a year, a one-third percentage point above market index for a whole year is so trivial compared to a year's worth of gains and losses, it's hard for me to believe it really means anything beyond randomness. Do not take my word for it, check with probability theory. Indeed, with your math background, no further explanation is necessary.

I do take issue with the size of the Investment Counselors' salaries. The explanation is 25% of industry standard, but that way of thinking has been forever shredded after September 2008. Wall Street mentality now resembles the Polish cavalry charging the German panzers in 1939, and STRS looks extraordinarily foolish beating that drum over and over. However, I also am not in favor of reducing them much because it breeds too much resentment. Better to adjust salary amounts with new hires. Your Investment Counselors aren't going to leave except under extreme conditions because they have too much invested in their pensions in OPERS. By the way, you need to move them over to STRS's system; it's nuts having them investing for one pension system and contributing to another; whatever aggravation is necessary to move them is worth it.

With your permission (which I take for granted), may I quote you?

"My view is that the real bottom line is not how much money we spend on incentives. The real bottom line is the monetary value that our investors add to the system. No one relishes paying high salaries, but outperforming the benchmark by directly investing in the stock market requires specialized expertise. That expertise can be expensive."

Here we will disagree. There is no question the size of the bonuses is absolutely trivial compared to STRS's overall asset value, but that's not the point. I firmly believe there should be no bonuses; again, it's a Wall Street thing. They expect them only because they've been convinced they deserve them. The whole plan logic is flawed for the simple reason you do not reward people to take risks with other people's money so they can get higher bonuses. You virtually ensure risk-taking entirely out of proportion to STRS's single-most important responsibility, namely preservation of capital. Not only that, but it creates a huge hostility between the retired membership and the Board; my best guess is the retired membership is against any bonuses by a 5:1 ratio, at least when STRS is losing money. You don't have to take my word for it, poll the members. I understand the conflict between what you know the membership wants and what you believe to be in the best long-term interests of everyone, but keep in mind the old union saying, "None of us is as smart as all of us."

From a retiree standpoint, here's what bothers me the most: the attitude our Investment Counselors are an untouchable sacred elite. They may be collectively very good, or not, but from where I sit the evidence either way is pretty scarce, and if you compare how well STRS's investments have done compared to the other Ohio retirement systems, it's pretty clear the contention our ICs are special is not sustained by the facts. I understand the Board feels it is under siege because of the losses and the bonuses, but the solution is for management to actually manage, not automatically take the side of the Investment Counselors and the Board to automatically back management. Let me posit a few questions; they're not questions you need to answer, they are explanations why the retired membership is so unhappy.

1. We lost $32 billion. Was that entire amount simply bad luck because the market went down? The current Board stance is, "Yep, every cent of that loss was simply bad luck." That is, I think you understand, not an attitude which inspires much confidence in management, the ICs, or the Board.

2. How many Investment Counselors who were eligible for a performance bonus didn't get one? We have what, 83 ICs? Losing $32 billion and then awarding performance bonuses to virtually everyone who is eligible for one is shouting to the heavens, "Our standards are the world's biggest joke."

3. I assume our ICs are evaluated. How many of our ICs got excellent evaluations and how many got poor evaluations? Except, how can you give a poor evaluation to an IC if you also awarded him a performance bonus. Answer: You can't. The system is so flawed and twisted, the way the PBI program is structured makes real evaluations close to impossible.

4. The market went down, we lost $32 billion, but that was because we were way too heavily into stocks instead of bonds and other less risky investments. Hindsight is real good like that. Why were we heavily into stocks? Because they have the highest return (when they go up), thus ensuring better bonuses. Again, you are encouraging risk taking with other people's (like mine) money. Had the ICs socked away some proportion in T-Bills or whatever, our losses would have been less. The more they socked away, the less would have been our losses. They socked away virtually nothing. That is a fact. Yet, they all (or almost all) still received performance bonuses for superior performance. Not many individuals will agree that was "superior performance." Or, is it the Board's fault when they did asset allocation?

We lost much more than we should have. Can't do anything about it now, tomorrow's another day. But, the horse may be gone from the barn, let's at least make sure the barn doesn't burn down also.

Rich DeColibus

Rich DeColibus is a retired member of STRS and past president (for 16 years) of the Cleveland Teachers Union.