Copyright © 2014 Albuquerque Journal
When it comes to New Mexico’s permanent funds, it’s a whole new world compared to five years ago.
Not only has the state recovered all losses from the Great Recession of 2008 and 2009, which had wiped away nearly a third of New Mexico’s savings, but the value of all the state’s permanent funds, taken together, has grown to 16 percent higher than before the market crash.
As of Dec. 31, the State Investment Council had an estimated $18.64 billion under management. That’s an all-time high, amounting to $2.54 billion more than the last record of $16.1 billion, which was reported before the recession in 2007.
Moreover, returns on fund investments by the SIC hit nearly 13 percent year-over-year on Sept. 30, placing New Mexico among the better-performing funds compared to its peers nationwide, according to the Wilshire Trust Universe Comparison Service, which tracks more than 75 public funds.
That’s in sharp contrast with performance comparisons in September 2009, when New Mexico ranked among the bottom 5 percent of funds across the country for year-over-year returns.
And while the SIC was buffeted in 2009 by pay-to-play scandals under the former state investment officer, Gary Bland, today the council is generally praised for sound investment strategies and decisions free of political influence.
Major portfolio overhaul
Clearly, some of today’s robust returns also reflect the current bull market for stock investments.
But SIC board members and staff say improvement in fund performance, plus the council’s smooth functioning nowadays, are the result of four years of steady, major reform in SIC structure and governance.
“The council has carried out one of the biggest portfolio overhauls in the country in the last several years,” said SIC spokesman Charles Wollmann.
That includes fundamental changes in everything from the makeup and selection of council members to how decisions are made and how money managers and consultants get hired.
And apart from structural changes, the council has carried out a thorough, bottom-up review and realignment of nearly all SIC investments and strategies, council member Harold Lavender told the Journal .
“We’ve completely reworked the portfolio,” he said. “It had to be totally restructured. We’ve roughly reinvested about $12 billion over the last four years.”
Taken together, the reforms have imposed a professional management process at all levels, including “best practices” regarding investment decisions, and transparency in all council proceedings and transactions, said SIC Vice Chairman Peter Frank.
Such changes were in direct response to how the council previously was run under Bland, who oversaw most decisions with little, if any, input from the board.
‘I was stunned’
It was previously pretty much just the vision of one person – the chief investment officer,” said Frank, who was first appointed in 2009. “When I got there I was stunned, because $10 billion to $11 billion from the permanent funds were being managed entirely by the head of the office based on what he thought should be done.”
That opened the doors to potential political influence. Pay-to-play scandals erupted in 2009, leading to Bland’s resignation that year, followed by SIC lawsuits against him and more than a dozen third-party marketers and placement agents.
The SIC estimates that tens of millions of dollars were siphoned away through improper payments and losses attributable to political influence in investment decisions.
The council has recovered about $26 million to date from some agents and investment firms, including Aldus Equity Partners and Vanderbilt Capital Advisors. But law suits are still pending against many more, including Santa Fe broker Marc Correra, who allegedly earned more than $20 million in “finders fees” for investments made by the SIC, and against his father, Anthony Correra, who was a close friend, fundraiser and political supporter of former Gov. Bill Richardson.
Steven Moise replaced Bland as state investment officer in 2010, and that year, the Legislature and the SIC initiated a wave of reforms, beginning with changes to the statutes regarding the number of council members and how they get appointed.
The council was expanded by law from nine to 11 members, with the number of governor appointees lowered from six to four and the Legislature given the right to appoint four members for the first time. The other council members include the governor, the state treasurer and the state land commissioner.
“The council now has a balance of elected officials, governor appointees and legislative appointees,” Wollmann said. “By creating that balance, we’ve taken potential for political influence to corrupt the process out of the picture.”
Arduous vetting process
The new council fired more than a dozen underperforming investment managers and consultants, then launched an arduous, transparent vetting process to hire replacements. That included nationwide requests for proposals for firms to manage about $3 billion in investments in large publicly traded companies, and $2 billion in investments in smaller public firms. In addition, the council removed a previous cap on payments for managers to attract more interest from top-performing management firms.
That led to 124 bids to manage stock investments in large companies, and 70 more for small-cap investments, Lavender said.
“For the large-cap investment managers, we devised a matrix process to narrow the list from 124 to 60 firms, then we analyzed the proposals from the remaining ones and cut the list to 11,” he said. “Those firms then came to Santa Fe for a dog-and-pony show to explain their proposals. We ultimately chose five managers, and we had staff do site visits to each one to make sure there were no hidden problems before the council hired them.”
The same process was applied to the 70 applicants for small-cap investments, with six eventually hired.
Apart from the lengthy vetting process, nearly all recommendations from the new investment managers are now brought directly to the council for final approval.
“Previous policy gave the state investment officer huge latitude, with him calling the shots on investments and basically no voting by the council,” Lavender said. “If he liked it, he made it happen, and if not, it didn’t. Now, the council votes to approve any investment over $50,000.”
Moreover, manager recommendations are thoroughly vetted by staff, consultants and committees before even going to the council for a public vote, Wollmann said. And to reinforce transparency, SIC meetings are webcast live, and most reports are published online for public access.
A fresh strategy
With new governance and oversight in place, the council drew up a fresh investment strategy to reduce risk while still generating acceptable returns.
The council lowered the annual investment return target from 8.5 to 7.5 percent to cut incentives for risk taking. It then approved a new emphasis on investment diversification to substantially reduce portfolio dependence on volatile stocks.
By law, the SIC only can invest up to 65 percent of permanent funds in public equities. But if other equity-type investments were included, such as risky collateralized debt options, then previous equity commitments actually totaled about 85 percent of the funds, Wollmann said.
Now, the SIC has lowered its investment target to just 46 percent in equities, including 31 percent in domestic and 15 percent in foreign stocks. It also lowered the investment target for “absolute returns,” which includes hedge funds, from 15 to 8 percent.
On the other hand, it increased targets for real-estate investments from 3 to 10 percent, and private equity from 6 to 10 percent. And it created a new category of “real returns” with a 10 percent target. That includes hard-asset holdings of things like timber and infrastructure.
Council members said diversification helps stabilize returns in the long term.
“We’re investing in more-conservative, less-volatile assets that aren’t in lockstep with the stock market, which will hopefully gives us more resiliency in down markets,” Lavender said. “We want little correlation between asset classes to balance the portfolio, so if one asset goes down, another one stays steady or goes up to balance things and protect the funds.”
Strong markets assist
But the SIC’s superior performance compared to peer funds shows the positive impact of new strategies , said state Sen. Tim Keller, D-Albuquerque, who has advocated for reforms in the Legislature.
“Measurements against our peers are particularly important,” he said. “The results clearly show we’re making better investment decisions.”
The SIC still ranks in the lower percentiles compared to peers for long-term returns over five or more years, reflecting continued drag from pre-2009 investments.
“We’re still stuck with some horribly bad legacy investments in the portfolio that continue to impact results,” Frank said. “It will take awhile to get out of that.”
But for shorter returns of one to three years, he said, SIC performance has gone from nearly last in the country to among the top third for most quarters in the last two to three years.