New York City's $140 billion retirement system pays Wall Streetmoney managers about $360 million a year, the only one of the 11biggest U.S. public-worker pensions that refuses to manage anyassets internally. Larry Schloss, the city's chief investmentofficer, says the practice must end.

Schloss, 58, points to Ontario's C$130 billion (US$126 billion)teachers' pension fund, which has returned an average 9.6 percentannually on its investments since 2003—1.6 percentage points betterthan New York's funds. The Canadian system reaped those gainsmostly without paying outside asset managers. Schloss says the samein-house approach could work in New York.

“I'm not looking for John Paulson,” said Schloss, who earns$224,000 a year, referring to the billionaire hedge-fund manager.“I'm just looking for a VP at MetLife who makes 500,000 bucks.”

Saving Money

The 38 staff members in the city comptroller's Bureau of AssetManagement oversee five funds for police, firefighters, teachers,school administrators, and civil-service workers. They get paid anaverage of $100,000 a year, less than the median base salary of afirst-year Harvard MBA graduate. They farm out asset management tomore than 300 firms.

Investing directly means the Toronto-based Ontario Teachers'Pension Plan doesn't have to pay outside managers 2 percent ofassets they oversee, plus 20 percent of profits, the typical feesfor hedge funds and private-equity and real-estate firms. It alsogives Ontario Teachers' more control over investments, ChiefExecutive Officer Jim Leech said in a telephone interview.

Among New York's outside arrangements is a $60 millioninvestment by four pensions in a real-estate fund sponsored byColony Realty Partners, a Boston-based private-equity firm thatoversees $3.2 billion. The fund has lost 15.5 percent since 2006,while Colony has reaped $7.7 million in fees, according to thecomptroller's office

Last year, three city pension funds paid more than $1.2 millionin fees on a $160 million investment in a real-estate fundco-sponsored by Fisher Brothers, a New York-based propertyinvestor, and Morgan Stanley, the New York bank. The fund hasreturned 0.3 percent since 2004. Another 2004 real-estateinvestment with Tishman Speyer Properties LP returned 58.8percent.

The city could hire a five-person real-estate team, pay themaround $2 million, and start doing some joint ventures, Schlosssaid. On a $1 billion investment that returns 12 percent, New YorkCity could save $20 million in fees over five years, he said.

Emily Margolis, a spokeswoman for Colony, didn't respond toe-mailed and telephoned requests for comment. Suzanne Halpin, aspokeswoman for Fisher Brothers, and Matt Burkhard, a MorganStanley spokesman, declined to comment.

California's Woes

Managing money internally and paying staff higher salaries andbonuses isn't always a formula for success. The California PublicEmployees' Retirement System, the largest U.S. pension, managesalmost two-thirds of its assets, including 83 percent of stocks and91 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 yearsending June 30, 2012 is 1.1 percentage point less than that of thePennsylvania Public School Employees' Retirement System. ThePennsylvania fund manages only 26 percent of assets internally andpaid Chief Investment Officer Alan Van Noord $269,302 in 2011.

New Jersey's $75.3 billion pension manages 73 percent of itsassets in-house, the most among the 11 biggest U.S. public funds.The system returned 6.4 percent for the 10-year period ending June30, 2012.

'Way Ahead'

New York City will pay $8 billion this year toward retirementbenefits, a cost that has risen more than fivefold since 2002.That's why Ontario Teachers' presents a model, Schloss says.

“They're way ahead,” Schloss said in an interview in hisseventh-floor office in the Municipal Building, which houses morethan 2,000 employees across from City Hall. The former global headof private equity at Credit Suisse First Boston, Schloss was hiredby Comptroller John Liu in 2010 to increase returns and reducecosts.

The Ontario fund employs a staff of investment managers earningan average of C$720,000 a year to increase assets worldwide. Theirinvestments include ownership of Toronto Eaton Centre and othershopping malls, a stake in Seoul-based Kyobo Life InsuranceCompany, and a 30 percent interest in Copenhagen's internationalairport.

Managing Managers

In New York, there's plenty of talent, and it's “ridiculous”that the city won't pay enough to hire it, Schloss said. A plan tomanage a portion of assets internally—with compensation levelsbenchmarked to New York City insurance companies, endowments, andpensions—hasn't gained traction with fund trustees, he said.

“We're not really in the asset-management business,” Schlosssaid. “We manage managers.”

Bringing Ontario's approach to New York may be a challenge.While the city's retirement system has about 60 cents of assets forevery $1 in obligations, union officials say they're wary oftinkering with it.

“Why would you try to dismantle a system that's performingwell?” said Greg Floyd, president of Teamsters Local 237, whichrepresents 24,000 city employees. Floyd sits on the board of thecity's $46 billion civil-employees' pension. Pension-fund trusteeshave to approve raising investment staff salaries and authorizeinternal asset management.

There's “a yearning” among union trustees to manage assetsin-house, though “we are never going to be able to payprivate-industry salaries to work in government,” said ManhattanBorough President Scott Stringer, a labor-backed Democrat runningfor comptroller who's favored to win. Liu, also a Democrat, isrunning for mayor. His term expires Dec. 31.

Replacing Staff

“When you get a new comptroller, you get a new chief investmentofficer,” Schloss said. “It's not good for performance to have asystem 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 97percent funded. By contrast, the total market value of the assetsof 109 U.S. state pension plans last year was 69 percent ofprojected liabilities, according to Wilshire Associates, a SantaMonica, 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 lastyear. The workers aren't government employees, meaning theirsalaries aren't subject to civil-service rules. High salaries andbonuses attract Wall Street-caliber talent, Leech said. About 35percent of assets are in so-called alternatives such as privateequity, real estate, and hedge funds.

“We compete with KKR,” said Leech, referring to theprivate-equity firm founded in 1976 by Jerome Kohlberg, HenryKravis, and George Roberts. “You don't want to go into that gamewith a second-stringer.”

The Ontario fund has a nine-member independent board that setspolicy and delegates day-to-day management to the professionalstaff. New York's five funds have 58 trustees spread across severalunions and political jurisdictions.

Two years ago, Mayor Michael Bloomberg and Liu unsuccessfullyproposed overhauling management of the five pensions to create asystem more like Ontario Teachers'. The mayor is the founder andmajority owner of Bloomberg News parent Bloomberg LP.

Accounting Background

The five boards were to be pared down to a single 12-member bodythat would set investment policy. Asset management would have beenseparated from the comptroller's office to insulate it frompolitics.

Instead of union officials and political appointees, OntarioTeachers' board members are chosen for their backgrounds inbusiness, finance, economics, and accounting. Only one board memberis a former teacher.

“What does a kindergarten teacher know about investing?” saidLeech.

When Schloss was chosen to oversee the city's pensions in 2010,Liu described the funds' structure in a press release as a“cluster$&*$.” Schloss persuaded trustees to increase theinvestment staff to 38 from 22. The pensions added hedge funds,opportunistic fixed income, and leveraged loans to the mix ofinvestment possibilities.

Pay Obstacle

To an inexperienced staff he added Barry Miller, a formermanaging partner at Nottingham Capital Management, to overseeprivate equity. He hired Seema Hingorani, former research directorat Pyramis Global Advisors to oversee hedge funds. Both earned$175,000 annually. Miller resigned to join Connecticut-basedprivate-equity firm Landmark Partners on May 20, said Matt Sweeney,a spokesman for the comptroller's office.

“We wanted to hire a number of people but couldn't because ofcompensation,” Schloss said.

Asset management staff are required to live in New York Cityunless they get a waiver. Obtaining one involves multiple agenciesand City Hall approval, Sweeney said.

The median sales price of a two-bedroom condominium in Manhattanwas $1.6 million in the first quarter of 2013, according toappraiser Miller Samuel Inc. and brokerage Douglas Elliman RealEstate.

“It's just really hard to say, 'Hey, come work here for $100,000and you have to live in the five boroughs,” Schloss said.

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