Rudy Fichtenbaum and a simple question for STRS and Callan

Where’s the Alpha?

Rudy Fichtenbaum 

August 24, 2023

Sometimes a picture is truly worth a thousand words, and this truism would appear to apply to understanding STRS returns. Since I have been on the Board, I have been arguing that active investing is a losing proposition. The STRS staff likes active investing -- picking winners and losers--because they get rewarded for beating benchmarks. The alternative to active investing is known as passive investing, which is index investing.

At the last Board meeting, in the discussion over Performance-Based Incentives (PBI a.k.a. bonuses), I pointed out that STRS has for years been comparing gross returns to benchmarks at the asset class. This is cheating. What is being done is not illegal because the policy of allowing gross returns to be compared to benchmarks has been approved by the Board, although it may very well be the case that most Board members did not know exactly what they were approving, or the implications of what they were approving.

I pointed out the use of these gross returns was totally misleading and asked why we were not deducting all expenses, both internal and external, from investment returns at the asset-class level. The response from the STRS staff was that we don’t have the internal expense data at the asset-class level, and so the best we can do is use semi-gross returns i.e., returns that are not net of internal expenses.

Why is this important? Think about it this way. Suppose you had a choice between putting some money into Bank A or Bank B. Bank A pays 5% interest but charges a 1% fee. Bank B pays 4.75% interest and charges a 0.25% fee. Hopefully it is obvious that if you deposit $100 into Bank A your gross earnings will be $5 compared to $4.75 in Bank B. But after fees you would have earned $4, net of fees from Bank A and $4.50 in Bank B. For STRS it is only the net amount i.e., the amount of money after fees that matters when it comes to paying benefits. So, in measuring performance all that really matters is the net return.

Well, it turns out that there is expense data at the asset-class level in a report that the CEM provides the Board every year. And according to CEM, they get their information from the STRS staff. I will have more to say about these expenses in a future post. But for now, I want to show you an example of why expenses matter and offer proof that passive (index) investing outperforms active investing.

The graph below shows annualized five-year net returns (returns after expenses) for STRS large-cap stocks from 2016-2020. The analysis ends at 2020 because that is the last annual CEM report made available to the Board. The first bar (in green) shows STRS internal passive returns for large-cap stocks was 16.4%. In 2020, passive investing accounted for 39% of large-cap stocks held by STRS. STRS active returns, where the STRS investment staff picked winners and losers, accounted for about 57%, shown by the second bar (in red). The return for internal active investing was 15.7%. For the most expensive active investing, external active investing, the return was 15.3%.

How important are the differences in returns? Total asset value of large-cap stocks in 2016 was $23.6 billion. Hypothetically, if all the large-cap stock had been invested passively, all other things being equal, STRS would have had an additional $951 million in assets when compared to STRS active management and $1.1 billion when compared to external active management.

The STRS staff and our consultants from Callan have repeatedly argued that STRS is rewarded for active investing i.e., they earn alpha, which is the return for active management. But the evidence seems to suggest otherwise. And so I ask, where’s the alpha?

Bill Neville's Contract (Golden Parachute!!!)

From John Curry

August 17, 2023

Posted on Facebook

Some of our members are curious if Bill Neville has a golden parachute. Here is his original contract (that has since been extended) so you can see for yourself. 

Dan MacDonald's remarks to the STRS Board, August 17, 2023

From Dan MacDonald

August 21, 2023

As schools open for a new school year, August closes out its STRS current Board. It can be a manipulative time. These two days of meetings will tell. In the past, personal contract changes have been made, Board policies changes have been voted. Arguments have been made as to an experienced Board versus a new Board in September. Remember that a brand-new set of teachers will start their journeys toward 35 years to full retirement while many will enter their final year of being active. All of you represent the members on the totality of the line, wherever an active is located. Meanwhile, some retirees have just started their pensions, while others will be coming to an end, literally. STRS and you represent them all.

With all that in mind, I am looking forward to the discussion on Performance Based Incentives and the report from the Members Benefit Department along with Public Participation [and the placement of daycare on September’s agenda.]

With my Public Participation remarks, I will be handing in current articles from The Ohio Capital Journal concerning CVS and Express Scripts. The AG is going after one and the Board of Pharmacy the other. The Health Committee should be meeting.

As always, actives need their benefits enhanced and retirees need a permanent 3% COLA restored.

Dan MacDonald's personal report on the August 17 and 18, 2023 STRS Board meeting

SUMMARY PERSONAL AUGUST STRS BOARD MEETING

Rob Walters and Dan MacDonald attended the August 17 & 18 STRS Board meeting. If you tuned in, thank you. If you stayed “tuned in” for the 5 hours executive session a special thanks for listening at 5:55 p.m. when the meeting resumed.

The 17th started with the Audit Committee which shared updates on internal audits being conducted. This was followed by a report from outside consultant Crowe LLP who is also conducting audits with a final report due December, 2023. Outside consultant ACA Group followed by its report that STRS is GIPS [Global Investment Performance Standards] compliant. It is the highest of accounting standards. Executive Director Neville followed with a Fiduciary Audit Update.

Funston Advisory Services was engaged by the Ohio Retirement Study Council to conduct a STRS performance audit which was completed May, 2022. Recommendations from this audit numbered 172. 33 recommendations are complete; 85 are in progress or planned; 49 are Board decisions [for which the Board is seeking an outside consultant] and 5 recommendations are “Disagree/Disagree in part.” Some of the recommendations’ “Highlights” include a statement of investment beliefs, Board meetings videoed and archived a year; preliminary Board materials available to public 2-days before a meeting; more town hall and other constituent group meetings to the public.

The actual Board meeting commenced at 10:05 a.m. After roll call and minutes approval, the Investment Department reported the fund return for June was 2.79% which showed investment assets increased by $2.4 billion during FY 2023 ending approximately at $90.1 billion. The total fund FY 2023 return was 7.68% gross. [Fichtenbaum pushed on this since costs were included. He is a lone voice. His point is that STRS should be reporting everything less costs [net] to get a true picture of assets and asset classes. I agree with him.

Remember the Fiscal Year [FY] ended June 30, 2023. Performance-Based Incentives are based on the closed numbers. Not to confuse this information, but Alternative/Opportunistic Investment numbers lag by a quarter, so will not be available until October. Remember the discrepancy in closing numbers last year FY2022. As I stated, Fichtenbaum is perhaps the most knowledgeable on this since Wade Steen has been removed and he now is a lone voice.]

The Investment Department updated on the search for a General Investment Consultant, proxy voting, a review of securities compliance policies and procedure, the semiannual derivatives exposure, and a Domestic Equities review [where for the first time ever I heard a department associate admit that STRS might have been able to do “a little better” if they reacted quicker in the 4th quarter. Truly, this is a good thing.] Outside consultant Callan then reviewed performance and STRS against its peers. STRS is on the right path and is great was the conclusion.

Public Participation had 15 individuals sign to speak. Fourteen spoke. Four passionate parents spoke on the childcare center sudden closure; another was not able because she had to return to work. Two spoke on transparency. One spoke on concern of newly elected Board members whose ideas could lead to devastating the pension. One spoke on soon-to-be former board member Lard's passion and service. Six spoke on the lost COLA.

At 12:55 p.m. the meeting was recessed for a “not earlier than 3 p.m.” return Executive Session. The Board returned at 5:55 p.m. The Performance-Based Incentive Program for FY2024 was presented. The program is voted yearly and has been in place for over 35 years [and always paid]. It is common amongst large pension plans which have a significant portion of assets internally managed. STRS manages internally 2/3 of its assets. Outside consultant CEM reports a $100 million savings because of active management. STRS reports performance over the benchmarks added over $2 billion in value during the past five years.

Changes from last year’s document were proposed and each gone over. [The font size presented and in documents you can download on STRS website,https://www.strsoh.org/, is probably a 9, very small. Not much discussion and the meeting adjourned at 6:23 p.m. [Twenty-eight minutes spent with intro and changes and a document for which a guest needed a magnifier. A document that is definitely a hot spot for many of the 500,000 STRS members.]

On Friday, August 18, the Board meeting came to order at 9 a.m. The 2024 Health Care Program was presented. Major changes. All enrollees will transition to CVS Caremark (CVS) from Express Scripts as of January 1, 2024. It was stated that nearly 95% should experience no disruption such as formulary changes, utilization management or tier changes. If there is a disrupted, CVS will notify individuals by mid-December.

The plan has 66,000 pharmacies, of which 9,000 are CVSs, in network including many chains like Kroger and independent pharmacies. Mail order will also continue through CVS although you will need to set-up payment. Under medical, all Medical Mutual, AultCare, Paramount and Health Care Assistance will transition to Aetna.

The Aetna Medicare Advantage Plan will have some enhancements. Everyone covered by an STRS plan will be receiving a new identification card for both medical and prescription drug by the December holidays. Information will start being mailed late September.

Open enrollment is November 1 through November 21. Understanding Your Health Care webinars will be offered Monday, October 30, Wednesday, November 1, Thursday, November 2, plus there will be a customer service number available, plus STRS own staff, to help everyone transition.

Following benefits, the meeting recessed to allow two governance consultants to be interviewed, AON and Nossaman. The Board meeting resumed with a resolution thanking Arthur Lard for his four years of Board service. Executive Director Neville then gave reports for July and August [no mention of the childcare center closing.] Eight reports for July and two for August. There were 2,689 retirements this summer.

The 2024 Performance-Based Incentive Program was then brought up for a vote. [Voting on this usually is part of presentation and was not brought up last evening or on today’s agenda – transparency] Back and forth discussion with praise of the document as steps toward a just and solid policy by Hunt, Bishop, Price, Falls, Herrington with Fichtenbaum and Sellers pushing back. The policy was amended to “If the Board’s actuary determines the System does not have at least a de minimis amount available under its Sustainable Benefit Enhancement Plan (SBEP) for the fiscal year during which Incentive Compensation is scheduled for payment, the Incentive Compensation for each Eligible Associate will be reduced by 10% [was set at 5%]. The policy passed 7 to 4 with Fichtenbaum, Foreman, Jones, and Sellers voting No.

Routine Matters followed. Payment of the FY2023 Performance-Based Incentive passed. Under old Business AON was approved as governance consultant. A vote was taken to establish a Legislative Committee, passed. Board member Jones requested the daycare situation be visited in an open session. Neville responded with “unprepared remarks” justifying the closure with some information. [To me it is a transparency issue. During Public Participation the closure of the daycare center is often brought up, as is selling or renting the building, the art within the building, the non-tax charged on cafeteria lunches, closing the cafeteria, heated sidewalks, a myriad of thoughts/suggestions.

Correthers reminded Jones that “we do not respond” to Public Participation. The Board should. It does not. The daycare center closing notice happened in July. It will now close the end of December. The Board did not even know of its closing from what I understand. Neville did step up to the plate and respond to Jones instead of hiding behind a blocking Chair, Correthers.] Fichtenbaum then brought up Roberts Rules of Order which will now be brought up as part of an agenda item in September. The meeting adjourned at 1 p.m. The next meeting is September 20-21-22.