Commonwealth of Massachusetts | Public Employee Retirement Administration Commission
Five Middlesex Avenue, Suite 304, Somerville, MA 02145
Ph 617 666 4446 | Fax 617 628 4002 | TTY 617 591 8917 | www.mass.gov/perac
Domenic J. F. Russo, Chairman | A. Joseph DeNucci, Vice Chairman
Mary Ann Bradley | Paul V. Doane | Kenneth J. Donnelly | James M. Machado | Donald R. Marquis
Joseph E. Connarton, Executive Director
M E M O R A N D U M
TO: All Retirement Boards
FROM: Joseph.Connarton, Executive Director
RE: Annual Memo on Investment Issues
DATE: February 1, 2008
As we have done over the years, it is time to release our annual memo reminding boards of various regulatory issues relating to investments. At the outset, I would just like to make it clear; PERAC’s investment regulations do not contain any meaningful restrictions on asset allocation. Either through existing regulations or through the supplemental regulation process, systems have always been able to invest in real estate and alternative investments in similar proportions as PRIT. There are no limits to international investing and/or emerging markets. There are no prohibitions on timber or any other asset class in which PRIT invests. Our hedge fund guidelines permit investment up to 10%, the same as PRIT. In short, there is nothing in PERAC’s investment regulations that prohibits local systems from having asset allocations similar to PRIT if they so choose. As in all actions, meeting its fiduciary duties should be the primary goal for retirement boards in determining asset allocation.
Furthermore, in addition to the regulatory flexibility that systems have, we encourage systems to come to us with new ideas. In recent years, we have approved requests from systems to invest in several new types of strategies such as 130/30, global alpha, real return, and infrastructure. Aspects of some of these strategies, such as “shorting” and the use of derivatives, may be at odds with certain regulations but may be addressed through the supplemental regulation process.
While some systems may not be comfortable with the perceived risk and liquidity characteristics of certain asset classes in the PRIT Fund, the fact that PRIT has been well rewarded for the risks it has taken cannot be disputed. When systems have a specific return target to meet, maintaining an investment program that is overly conservative may increase the risk of not achieving the target return. Just as there is no vice in taking well-considered and controlled risks, there is no virtue in having portfolios that are purposefully too risk-averse. For further discussion of these and other pertinent issues, please see the Best Practices Manual we published last year.
While most local systems can and do match PRIT’s performance in stocks and bonds, the PRIT Fund, because of its size, is able to gain access to top-tier managers in alternative investments (where the typical differential between top and lower tier performers is extraordinarily wide) and is also able to invest in real estate more efficiently and advantageously. Its economies of scale allow it to negotiate the lowest possible fees in every asset class. PRIT’s success mirrors the basic fact that, in every category of institutional investing (public pension plans, private pension plans, endowments, et al.), larger funds have significantly outperformed their smaller counterparts in recent years, mainly as a result of their ability to efficiently invest in a wide range of asset classes and their access to the best managers in the crucial nontraditional asset classes that have done so well in recent years. More than fifty local systems have benefited from using PRIT’s segmented offerings in these diversifying asset classes.
As you know, the PERAC Investment Unit seeks to support the local systems in the development and execution of their investment programs in any way possible. We encourage inquiries of any type and are pleased to attend board meetings upon request.
In this annual memo, we typically remind systems of the importance of complying with the regulations requiring 1) periodic performance and strategy reviews with all investment managers and 2) annual determinations of whether managers are satisfactorily fulfilling their mandates. The events of 2007, when a few supposedly safe short-term investment portfolios were impacted by holdings of Structured Investment Vehicles (SIVs) and some conventional longer term funds were impacted by holdings of complex instruments such as Collateralized Debt Obligations (CDOs), vividly demonstrated the importance of closely monitoring managers. In your reviews, board members should not hesitate to ask even the most seemingly basic questions. As part of the reviews, periodic portfolio listings and transaction journals should be examined and, if anything seems unusual, board members should question whether certain securities are consistent with account guidelines and whether certain trading patterns or turnover rates seem unusual. As we said in last year’s memo, “Exposure to investment disappointments can sometimes be avoided by simply looking at managers’ portfolios and questioning something that doesn’t look quite right.”
As we’ve previously stated, investment managers frequently call PERAC to seek clarification on confusing questions that appear on systems’ RFPs, such as those that ask whether prospective managers are “PERAC-approved” for certain asset classes. Once again, it must be stressed that there is no separate process for managers to obtain “PERAC approval”. The list of managers distributed quarterly by PERAC simply lists those managers in certain asset classes that have been hired by one or more systems, that have submitted a satisfactory exemption application form, and whose products remain open to new investment. The exemption process does not apply at all to domestic equity and fixed income managers. As is stated in the memorandum that accompanies the quarterly manager listings, boards are free to consider managers not on these lists in their search processes. If boards are simply trying to ascertain whether prospective managers have existing Massachusetts public fund clients, they should try to ask the question in a more direct manner. In any case, whether or not a manager has existing Massachusetts clients should not be a reason for either inclusion or exclusion in any search. (This, of course, also pertains to searches for investment consultants.) The PERAC Investment Unit is pleased to offer assistance to systems in the preparation of their RFPs. As always, we also welcome questions from board members about any aspect of the investment regulations.
Systems that hired investment consultants in 2003 are reminded of Regulation 26.04(3) which requires re-certification of consultants every five years. As explained in PERAC Memo #9/2004, re-certification does not require a new search process but simply a determination by the board and the subsequent submission of updated regulatory forms.
Systems that haven’t submitted a revised and updated Statement of Investment Objectives in several years are reminded of Regulations 18.01, 18.02, and 18.03. In addition to the regulatory requirement, completion of these forms should be a constructive exercise for systems in terms of specifying the objectives, policies, characteristics, and risks inherent in their investment programs.
For further assistance on these or any other investment matters, retirement boards are encouraged to call Investment Director Robert Dennis at 617-666-4446 ext 922.