Rich DeColibus to STRS Board: STRS would be far better off eliminating the PBI program, not just tinkering with it

From Rich DeColibus, May 16, 2009
Subject: PBIs

".....being in the middle of the lemming pack is not much of an excuse for going off the cliff"

".....had STRS invested in 5% return T-bills for the last eight years, it would have been far better off today, by tens of billions of dollars"

".....any suggestion to permanently eliminate the COLA lessens everyone's buying value year after year after year, virtually guaranteeing an impoverished living standard as time goes on"

"Professionals are supposed to do their best for their client. Without bonuses as incentives. That is the definition of a professional. My presumption is our investment counselors will act professionally, and if they do not, that is why we have a management. Frankly, again, if the whole department would have been dismissed eight years ago, we'd be tens of billions of dollars richer."

Gentle(wo)men:

I believe the argument over whether PBIs should be extended when STRS loses total assets is like being unable to see the lake because of glare off the water. The fundamental question is whether there should be PBIs AT ALL, not just when our total asset value is down. My conclusion is STRS would be far better off, in every way that is important, by scrapping the whole program, not just tinkering with it. Bear with my logic.

The Board in the past was sold PBIs as a standard way of doing this kind of business, a replication of Wall Street employment practices, and a practice without which STRS would be left without competent investment counselors. My understanding is virtually no one currently on the Board was actually there when this practice started; most of you simply inherited it. Various experts have either validated the practice or judged it excessive and unwarranted (you can, in short, get any opinion you want if you shop around for it). More to the point, what may have been true in the past is no longer true. There has been a sea-change in accepted thinking about what constitutes appropriate compensation; granted many on Wall Street are doing their best to "Bring back the good old days," but there is now a tidal wave of anger and condemnation against huge salaries and grotesque bonuses as rewards for, at best, mediocre performance. Think of the AIG bonuses, if you need a solid example.

The number one responsibility of the STRS Board is preservation of capital. It is NOT a given percent of return (like an average of 8% per year). If you inspect the record, it is crystal clear all those years of wonderful returns were completely washed away by one catastrophic year (the most recent one). Not only is there no guarantee this will not happen again, in the mostly free market of America, it's virtually a certainty this will happen again. It is not a good thing for the situation to have deteriorated to such a degree that the Ohio General Assembly is now interested.

Your responsibility was to avoid this catastrophic loss, not maintain 8% returns year-after-year only to see it all lost by a failure to anticipate a bad year. Yes, few others were clever enough to see what was coming, but being in the middle of the lemming pack is not much of an excuse for going off the cliff. The fact of the matter is brutally obvious: had STRS invested in 5% return T-bills for the last eight years, it would have been far better off today, by tens of billions of dollars. Your current PBI program simply encourages investment counselors to invest in riskier vehicles than are appropriate, because the rewards for them personally are great (the bonuses) and the risks are all taken by us who have a vested interest in STRS (which is none of the investment counselors).

Professionals are supposed to do their best for their client. Without bonuses as incentives. That is the definition of a professional. My presumption is our investment counselors will act professionally, and if they do not, that is why we have a management. Frankly, again, if the whole department would have been dismissed eight years ago, we'd be tens of billions of dollars richer. That is a fact. If you insist on hanging on to the department, then at least expect them to be professionals, just like the teachers and administrators who put a lifetime of their savings into the pot. That does not seem like such an unreasonable request.

The suggestion to eliminate the COLA is a horrible one. It penalizes every individual who has already retired, and the younger they are, the more it penalizes them. In years where the cost of living is stagnant (such as this year), not a problem, but any suggestion to permanently eliminate the COLA lessens everyone's buying value year after year after year, virtually guaranteeing an impoverished living standard as time goes on. This is not what STRS is supposed to stand for. Please discard this really bad idea forever. Losing the 13th check is one thing, but a COLA is absolutely essential to maintaining a normal but modest life style into the retirement years, especially as unreimbursed health care costs mount, which they tend to do as the years go by. The federal government's COLA calculation doesn't even include the price of gasoline or food, two of the most volatile price indexes in existence. Does anyone think, running up a trillion and a half dollars of federal government debt, isn't going to skyrocket the inflation rate in the near future?

We need to look to the future, not rest on the outdated and clearly failed business practices of the past.

Rich DeColibus

[Rich is a retired teacher and former president of the Cleveland Teachers Union.]

STRS Investment Return vs Treasury Bill Return

From Mario Iacone, May 12, 2009

IMPORTANT FACT/ESTIMATE: TABLE ONE shows at least what 2009 STRS assets would be if the 1998 asset value would have been invested in low and no risk investments averaging Five Percent.

TABLE TWO lists Treasury Bill rates since 1998 showing that at least a 5% Return would have been easily attainable over the period of time shown in TABLE ONE.

Click image to enlarge.

No doubt, it will be pointed out that stock market investments will do much better and probably average 10% over the long term, and that return might be attainable, although such is not true for the period of 1998 to 2009.

However, there is a serious flaw in such Long Term

projections. Large Short Term losses cause serious financial hardship for both the active and retired members of STRS.

The current situation best illustrates that point. Due to large short term losses, STRS members are confronted with:

• Increases in Contributions.
• Higher Retirement Age.
• Worse Final Average Salary.
• Reduction/Elimination of COLA.
• Worse yet, we are paying high salaries and b onuses to get that.

Will it matter to those that suffer those cuts, if in 2024, STRS can show an average return of 10% on their investments?

STRS should note that it is NOT a Wall Street Bank or Wall Street Investment Firm, but a RETIREMENT SYSTEM.

STRS must implement an investment strategy that offsets huge short term losses to avoid a repeat of the same problem a short time into the future.

Live link from Table 2: www.federalreserve.gov/releases/h15/data.htm

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.

Active teacher to Laura Ecklar: I see a lot of spin and very little common sense

Now this response makes "sense to me." Thanks [~~~] for clarifying things for Ms. Ecklar.

Jim Stoll

From [Active teacher, name withheld], April 16, 2009
Subject: Re: Response to E-Mail

Ms Ecklar,

Thank you for your response. From my vantage point I see a lot of spin and very little common sense. Freezing salaries through 2010 is not overly impressive. Most of us in the real world have experienced wage freezes from a number of years already. Comparing compensation practices of public vs professionals is at the center of my anger in that this culture of rewarding without producing results is what has gotten our entire country into the mess it is in.

What I know is the STRS has lost a tremendous amount of money through the investments that they have made. I could care less if that loss is more or less than the average - it is still a loss and that will directly impact on my retirement. You can spin it all you want, but when your job performance results in significant losses you don't deserve double digit raises and any type of bonus. What happened in 2004 or how the investment set up at STRS saves money is irrelevant. The bottom line is we didn't do very well with our investments in the past year..

This concept simply parallels the AIG fiasco. How in the world can AIG take billions of tax payer money to stay afloat and then turn around a reward executives with bonuses? When will common sense ever enter the picture in the investment world??

It really should be a very simple concept - if you perform well you get rewarded and when you don't perform well you don't get rewarded.

Rewarding ANYONE at a time when retirement benefits are at risk is inexcusable. Please make sure Mr. Nehf knows how I feel.

[~~~]

From Laura Ecklar, April 16, 2009

Dear [~~~],

Our executive director, Michael Nehf, has asked that I respond to your recent e-mail regarding eliminating bonuses for our Investment Department staff. As you will read below, based on recent actions by the Retirement Board, base salaries for all STRS Ohio associates have been frozen through June 30, 2010, and Performance-Based Incentives or PBIs have been reduced. Please know that we recognize that there is a significant difference between compensation practices and levels for most public educators versus investment professionals. Further, we know that it can be difficult to understand how investment staff could be rewarded for their work when the overall value of investments has declined. So, if I may, I would like to share some additional information with you about our PBI Program for eligible Investment Department associates and other staff compensation. As you read through this, I hope you will see why we have a PBI Program, as well as get a sense of the changes our Retirement Board has recently made in compensation, not just for investment staff, but for all STRS Ohio staff, in recognition of the current economic times.

In managing our billions of dollars in investments, STRS Ohio has three basic choices. We can hire outside investment managers, we can do much of the investing "in-house," or we can purchase only passive investments, which require minimal staff. Though we use all three methods for portions of our investments, associates in the Investment Department handle about 80% of STRS Ohio's investments in-house.

STRS Ohio's members have been well served by the system's dedication to managing a large percentage of the system's assets internally and actively. STRS Ohio benefits from significant cost savings each year due to the lower cost of internal management by STRS Ohio associates compared to paying fees to external money managers. The savings from internal management totaled $100 million in calendar year 2007 alone. Additionally, for the time period of July 1, 2004, through Jan. 31, 2009, the net value added from active management after deducting all direct investment costs, including earned PBI payments during that period, was .65% or about $1.8 billion. This represents the additional value brought to STRS Ohio through active management by STRS Ohio associates and external managers, above and beyond passively indexing system assets.

To compensate these Investment associates, the Retirement Board uses a combination of a base salary and variable pay (pay that is "at risk"). Eligible Investment Department associates can receive an additional percentage of their base salary through a PBI payment, based on total investment fund performance and their individual goals over one- and five-year periods compared to the respective benchmark.

The Retirement Board's goal is to maintain total compensation for eligible Investment Department associates (base salary plus maximum PBI) at the bottom quartile (25%) of total compensation levels in the private market (i.e., 75% of private sector investment professionals can earn more).

The PBI payments made in September 2008 included our last fiscal year, which ran from July 1, 2007, through June 30, 2008. During that time period, the total investment fund return was a negative 5.44%. However, the benchmark return was a negative 5.79%. When markets decline, the value of our investment assets decline. 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.

So, in the case of fiscal year 2008, our total fund return beat the composite benchmark return and the value of investment assets stood at $70.3 billion. Active management by our STRS Ohio Investment Department associates and external managers resulted in an additional $215 million beyond benchmark returns for the investment fund, and your pension plan benefited. That is why PBIs were awarded.

If you still have your October 2008 STRS Ohio newsletter, you will see an article and accompanying chart that shows the performance of each asset class against its benchmark, resulting in the net value added that I refer to above. (The October newsletter can also be accessed via the STRS Ohio Web site at www.strsoh.org.)

As you know, the global markets have experienced a rapid and significant downturn since last summer. For STRS Ohio, this has meant a drop in the value of our investment assets by more than $22 billion since July 1, 2008. As of March 31, 2009, the estimated market value of investment assets is $47.8 billion. And, it has resulted in the Retirement Board examining whether current compensation levels for Investment associates should be maintained during this period of significant loss in asset value. During the last several months, the board has made changes to the PBI Program that include:

* Suspending the current PBI Program for 2009 as of Feb. 1, 2009. With this suspension, calculations for any earned PBIs for this fiscal year will generally be based upon the performance results for the first seven months of the year, and the longer five-year period (the board will not be voting on these PBIs until September 2009); and
* Reducing any earned PBIs for the 2010 PBI Program by up to 60% if the total STRS Ohio investment fund has a negative absolute return.

Several weeks ago, the board approved a further change to the 2010 PBI Program that states if STRS Ohio's total investment fund earns a positive absolute return, but the total market value of investment assets is less than $65 billion at June 30, 2010, then each PBI payment will be reduced by three percentage points for every $1 billion (and fraction thereof) of the shortfall from $65 billion. At its April 2009 meeting, the board will be presented with the final fiscal year 2010 PBI Program document for approval.

The board also implemented a salary freeze for all associates in February that extends through June 30, 2010, as well as an associate head count freeze. This will reduce expenditures in the coming fiscal year by about $2 million.

The March STRS Ohio newsletter includes a lengthy article about the impact of the global market downturn on STRS Ohio and its impact on our long-term pension fund liabilities and our health care program. As a result, the Retirement Board has begun a long-term contingency planning process to address these issues.

It is absolutely imperative that STRS Ohio watches every dollar that it spends, whether markets are up or down. However, just reducing operating expenditures cannot solve the long-term issues we face in funding pensions for future generations of teachers and a viable health care program. We are in the midst of challenging economic times. We will continue to do our best to help members understand where their dollars are being spent - and why.

We hope, in turn, that you will continue to read our newsletters, visit our Web site and register for our e-mail news service to keep abreast of your board's discussions and decisions.

I apologize for this lengthy response, but your comments are important to us and I wanted to make sure you had complete information. Again, thank you for writing and sharing your viewpoint with us.

Laura Ecklar

Director, Communication Services

STRS comes up with a figure that "nobody supposedly knew or cared about"...on the very next day! Gee -- imagine that!!

From John Curry, October 20, 2008
Columbus Dispatch
October 20, 2008

Scratch that - We lost $7.8 billion!

The Ohio State Teachers Retirement System told The Dispatch repeatedly last week that it couldn't say how much it had lost during the October stock market drop, when indexes took historic plunges.

The most current figure STRS could provide was through Sept. 30, the end of the last quarter, said agency spokeswoman Laura Ecklar, noting that the system is a long-term investor unconcerned with the short-term swings of markets. However, by the next day, STRS had somehow come up with the loss figure that nobody supposedly knew or cared about when it reported to its board that in the first 10 trading days of October, it had lost another $7.8 billion, or 12.4 percent of the fund, which stood at $55.1 billion, according to board member Dennis Leone.

"In 12 months we've dropped $25 billion," or 31 percent, Leone said.

One agency that is beating the big stock-heavy state pensions funds by losing less is the Ohio Bureau of Workers' Compensation, which after the Noe scandal went highly conservative in its investments with 80 percent in bonds and 3 percent in cash. Through last Friday, its fund was down 13.9 percent from the start of the year, and stood at $15.4 billion, an official said.

Posted by Bill Bush, education reporter on October 20, 2008

Uh........wonder how many billions we lost this week (and it's only Tuesday) - think they'll tell us?

From STRS, September 30, 2008
Subject: [News] STRS Ohio Retirement Funds Remain Safe and Secure, Despite Market Turmoil

STRS Ohio members who are following news reports of the recent impact that the nation's credit crisis has had on global financial markets might wonder how this affects their pension fund. Times like these are a good time to remind our members that STRS Ohio pension benefits are safe and secure. STRS Ohio is a long-term investor with an extremely diversified portfolio. This design enables us to weather the ups and downs of the market, including the investment-related market losses we have recently experienced due to the credit crisis and the overall general market decline.

The system's assets, along with contributions from members and employers, are used to pay benefits earned by its members. However, it's important to remember that not all of those benefits are due at once. Many of our members who are accruing benefits will not retire for many years. In other words, STRS Ohio has the liquidity needed to pay pension benefits when they are due near term, and the accumulated investment assets and income from employer and member contributions (future revenues) to allow us to continue to do so into the future.

The recent events on Wall Street are unprecedented. Nevertheless, it is not time for knee-jerk reactions or to change the disciplined approach to investments that has served STRS Ohio well over the years. We are monitoring how the overall markets respond to discussions in Washington. We hope that steps will be taken that will restore both calm and confidence to the markets. During this period, we will continue to do what we do best as a public pension plan -- maintain our long-term focus and only make significant changes after thorough and deliberative discussions.

We encourage all our members to read our newsletters and visit our Web site often to keep abreast of all issues and events affecting their retirement system.

http://www.strsoh.org/