(Bloomberg) -- New York Citys $140 billion retirement system pays Wall Street money managers about $360 million a year, the only one of the 11 biggest U.S. public-worker pensions that refuses to manage any assets internally. Larry Schloss, the citys chief investment officer, says the practice must end.
Schloss, 58, points to Ontarios C$130 billion ($126 billion) teachers pension fund, which has returned an average 9.6 percent annually on its investments since 2003 -- 1.6 percentage points better than New Yorks funds. The Canadian system reaped those gains mostly without paying outside asset managers. Schloss says the same in-house approach could work in New York.
The 38 staff members in the city comptrollers Bureau of Asset Management oversee five funds for police, firefighters, teachers, school administrators and civil-service workers. They get paid an average of $100,000 a year, less than the median base salary of a first-year Harvard MBA graduate. They farm out asset management to more than 300 firms.
Investing directly means the Toronto-based Ontario Teachers Pension Plan doesnt have to pay outside managers 2 percent of assets they oversee, plus 20 percent of profits, the typical fees for hedge funds and private-equity and real-estate firms. It also gives Ontario Teachers more control over investments, Chief Executive Officer Jim Leech said in a telephone interview.
Among New Yorks outside arrangements is a $60 million investment by four pensions in a real-estate fund sponsored by Colony Realty Partners, a Boston-based private-equity firm that oversees $3.2 billion. The fund has lost 15.5 percent since 2006, while Colony has reaped $7.7 million in fees, according to the comptrollers office.
Last year, three city pension funds paid more than $1.2 million in fees on a $160 million investment in a real-estate fund co-sponsored by Fisher Brothers, a New York-based property investor and Morgan Stanley (MS), the New York bank. The fund has returned 0.3 percent since 2004. Another 2004 real-estate investment with Tishman Speyer Properties LP returned 58.8 percent.
The city could hire a 5 person real-estate team, pay them around $2 million and start doing some joint ventures, Schloss said. On a $1 billion investment that returns 12%, New York City could save $20 million in fees over five years, he said.
Emily Margolis, a spokeswoman for Colony, didnt respond to e-mailed and telephoned requests for comment. Suzanne Halpin, a spokeswoman for Fisher Brothers and Matt Burkhard, a Morgan Stanley (MS) spokesman, declined to comment.
Managing money internally and paying staff higher salaries and bonuses isnt always a formula for success. The California Public Employees Retirement System, the largest U.S. pension, manages almost two-thirds of its assets, including 83 percent of stocks and 91 percent of bonds. Chief Investment Officer Joseph Dear received $522,540 in compensation in 2011.
Yet its 6.1 percent average annual return for the 10 years ending June 30, 2012 is 1.1 percentage point less than that of the Pennsylvania Public School Employees Retirement System. The Pennsylvania fund manages only 26 percent of assets internally and paid Chief Investment Officer Alan Van Noord $269,302 in 2011.
New Jerseys $75.3 billion pension manages 73 percent of its assets in-house, the most among the 11 biggest U.S. public funds. The system returned 6.4 percent for the 10-year period ending June 30, 2012.
New York City will pay $8 billion this year toward retirement benefits, a cost that has risen more than fivefold since 2002. Thats why Ontario Teachers presents a model, Schloss says.
Theyre way ahead, Schloss said in an interview in his seventh-floor office in the Municipal Building, which houses more than 2,000 employees across from City Hall. The former global head of private equity at Credit Suisse First Boston (CSGN), Schloss was hired by ComptrollerJohn Liu in 2010 to increase returns and reduce costs.
The Ontario fund employs a staff of investment managers earning an average of C$720,000 a year to increase assets worldwide. Their investments include ownership of Toronto Eaton Centre and other shopping malls, a stake in Seoul-based Kyobo Life Insurance Company (KYLINZ), and a 30 percent interest in Copenhagens international airport.
In New York, theres plenty of talent and its ridiculous that the city wont pay enough to hire it, Schloss said. A plan to manage a portion of assets internally, with compensation levels benchmarked to New York City insurance companies, endowments and pensions, hasnt gained traction with fund trustees, he said.
Were not really in the asset-management business, Schloss said. We manage managers.
Bringing Ontarios approach to New York may be a challenge. While the citys retirement system has about 60 cents of assets for every $1 in obligations, union officials say theyre wary of tinkering with it.
Why would you try to dismantle a system thats performing well? said Greg Floyd, president of Teamsters Local 237, which represents 24,000 city employees. Floyd sits on the board of the citys $46 billion civil-employees pension. Pension-fund trustees have to approve raising investment staff salaries and authorize internal asset management.
Theres a yearning among union trustees to manage assets in-house, though we are never going to be able to pay private-industry salaries to work in government, said Manhattan Borough President Scott Stringer, a labor-backed Democrat running for comptroller whos favored to win. Liu, also a Democrat, is running for mayor. His term expires Dec. 31.
When you get a new comptroller, you get a new chief investment officer, Schloss said. Its not good for performance to have a system where your senior staff turns over every four years.
The Ontario fund, which also has offices in London and New York, manages more than 80 percent of its assets in-house and is 97 percent funded. By contrast, the total market value of the assets of 109 U.S. state pension plans last year was 69 percent of projected liabilities, according to Wilshire Associates, a Santa Monica, California-based consulting firm.
What sets Ontario Teachers apart is governance and compensation, Leech said.
The fund paid its 250-person investment staff C$180 million last year. The workers arent government employees, meaning their salaries arent subject to civil-service rules. High salaries and bonuses attract Wall Street-caliber talent, Leech said. About 35 percent of assets are in so-called alternatives such as private equity, real estate, and hedge funds.
We compete with KKR, said Leech, referring to the private-equity firm founded in 1976 by Jerome Kohlberg, Henry Kravis and George Roberts. You dont want to go into that game with a second-stringer.
The Ontario fund has a nine-member independent board that sets policy and delegates day-to-day management to the professional staff. New Yorks five funds have 58 trustees spread across several unions and political jurisdictions.
Two years ago, Mayor Michael Bloomberg and Liu unsuccessfully proposed overhauling management of the five pensions to create a system more like Ontario Teachers. The mayor is the founder and majority owner of Bloomberg News parent Bloomberg LP.
The five boards were to be pared down to a single 12-member body that would set investment policy. Asset management would have been separated from the comptrollers office to insulate it from politics.
Unfortunately, the plan was cut off at the knees by some of the unions, said Marc LaVorgna, a spokesman for the mayor. Considering the massive upside for the taxpayers from getting even slightly better returns, this is worth looking at.
Instead of union officials and political appointees, Ontario Teachers board members are chosen for their backgrounds in business, finance, economics and accounting. Only one board member is a former teacher.
What does a kindergarten teacher know about investing? said Leech.
When Schloss was chosen to oversee the citys pensions in 2010, Liu described the funds structure in a press release as a cluster$&*$. Schloss persuaded trustees to increase the investment staff to 38 from 22. The pensions added hedge funds, opportunistic fixed income and leveraged loans to the mix of investment possibilities.
To an inexperienced staff he added Barry Miller, a former managing partner at Nottingham Capital Management, to oversee private equity. He hired Seema Hingorani, former research director at Pyramis Global Advisors to oversee hedge funds. Both earned $175,000 annually. Miller resigned to join Connecticut-based private-equity firm Landmark Partners on May 20, said Matt Sweeney, a spokesman for the comptrollers office.
We wanted to hire a number of people but couldnt because of compensation, Schloss said.
Asset management staff are required to live in New York City unless they get a waiver. Obtaining one involves multiple agencies and City Hall approval, Sweeney said.
The median sales price of a two-bedroom condominium in Manhattan was $1.6 million in the first quarter of 2013, according to appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate.
Its just really hard to say, Hey, come work here for $100,000 and you have to live in the five boroughs, Schloss said.