Many of America's public retirement schemes believe Asia's alternative asset space offers opportunistic appeal. But they face several problems in taking advantage of it.
Perhaps the most sensitive? The difficult politics around paying international investment experts.
US state pension funds have a strong home-country bias. In addition, they have limited appetite for illiquid assets, courtesy of generally inadequate funding levels – the average state pension only had enough assets to cover 69% of its its payout liabilities as of end-2017, said US think tank Pew Charitable Trusts in a report this year.
That combination makes them particularly cautious of overseas alternative investments, the trade body official added. Overcoming this would typically require stationing executives in other regions such as Asia, to conduct internal research, monitor local partners or make direct investments in the region.
But hiring such overseas experts is costly. And staff compensation is a thorny question for US public pensions.
They have to endure fierce political and public scrutiny of pay levels. That makes it hard to attract and retain strong investment talent, said Rich Nuzum, New York-based president of the retirement and investments business at consultancy Mercer.
The debate about how much state retirement funds should compensate senior members continues to play out in the US media, he pointed out. “There have been board members disagreeing with each other and some politicians taking issue with staff payment levels.”
It’s both simple and politically popular to argue that public funds absorbing money from regular workers shouldn’t pay their executives huge salaries. But there’s a big catch.
“The individuals who don’t like pension funds paying investment staff six figures plus bonus also don’t like them paying private equity and real estate managers what they see as high fees,” said Nuzum. “But if you don’t have high-quality in-house staff and good partners you can’t play in private markets in Asia – you’d be the dumb money at the table.”
In contrast, funds that pay their in-house staff relatively well are more likely to establish satellite investment offices on-the-ground in Asia and elsewhere, to improve their access to investment opportunities and support their due diligence on local direct and co-investment opportunities.
BENEFITS OF PAYING MARKET RATE
"This debate is ongoing over whether investment staff are worth high salaries – but we work in an environment where such skills have high value," Nuzum said.
In Canada there is that debate too, but most funds there are ready to pay their staff market rates of compensation. Hence public funds in Canada tend to be more sophisticated and better staffed than many of their US peers.
"Where below-market compensation is the norm, a US public fund risks serving as a training ground for investment staff," Nuzum said. "They may often move on to a Canadian fund or US corporate, endowment or family office that pays market rate, or even to an Asian or Middle Eastern fund that will pay more competitively."
Research has demonstrated the benefits of the Canadian pension managers' pay policies, he added.
In an August 2017 paper, for instance, Keith Ambachtsheer, founder of Toronto-based CEM Benchmarking, compared the performance of eight large Canadian public pension funds against that of 132 other pension funds and other long-horizon investment funds. The research found that those using the “Canadian model” have added additional value of $4.2 billion annually over the past 10 years.
The big obstacles involved in justifying offices overseas are likely why it has taken several years for the Teacher Retirement System of Texas to reach the stage of preparing to set up a Singapore office. Indeed, it is believed to be the only large member of its peer group to be doing so.
Jerry Albright, Texas Teachers' chief investment officer, underscored the challenge in June last year, when he told AsianInvestor: “We won’t have so many people on the ground or do as much in-house investing [as the likes of Canadian pension funds or some sovereign wealth funds]. We are going to make the best use of the resources we have; we don’t have unlimited resources like some other funds."
Still, it's likely that the need for US pension funds to source better returns will eventually pressurise more of them to follow in the footsteps of the Texan asset owner – even if US president Donald Trump and some politicians such as senator Marco Rubio don't like it.
The ultimate priority of the pension funds is to maintain sufficient capital to support their members in retirement. And to do that it makes sense to build exposure to a region that’s likely to be the biggest driver of global growth for decades to come.
Trade wars come and go, but pension liabilities last forever.
This article has been adapted and updated from the feature 'US state pensions' Asia dilemma' in the latest (Autumn 2019) issue of AsianInvestor magazine.