Q&A talks investment strategy with State Treasurer Denise Nappier, who has made headlines for her aggressive stance in managing Connecticut's public pension funds.
Q: You joined with eight public pension funds representing more than $500 billion in assets under management in urging Massey Energy shareholders to withhold support for board members (who ended up being narrowly re-elected) because of the company's safety record. Is activism good when it comes to where the state's retirement money is invested?
A: Yes. I believe that working with the companies in which state pension assets are invested can protect and enhance the value of our long-term investments. In fact, all that I do as a fiduciary is grounded in the ultimate principle that my actions increase shareholder value over the long run. That is for the 160,000 participants and beneficiaries of the Connecticut pension fund who depend on these assets for their future financial security. As we have seen all too clearly in the recent past, poor corporate governance can lead to poor oversight of management and loss of shareholder value. Take, for example, Enron and Lehman Brothers — both had poor corporate governance and oversight. Polaroid and National Cash Register missed the onset of the digital age. Where are those companies today? They are gone. So it's clear that failing to fully consider risks and opportunities can have significant impact on our investments. When companies manage looking in the rear view mirror, they lose out to those with a vision of the future.
Q: Is responding to specific events good investment strategy for long-term growth? Or, does this kind of activism reflect only a small part of the state's portfolio?
A: A specific event often warns of a larger problem. For example, we had identified Massey Energy as a problem company in terms of its corporate governance prior to the horrible mining accident in West Virginia that took 29 lives. That event focused other investors on these governance issues as well. Excessive executive compensation is often a sign that the board of directors is dropping the ball on overseeing other aspects of management as well. Let me also make clear that not all of our portfolio companies are bad actors. Most are focused on pursuing long-term sustainable growth and success and doing so responsibly. Typically, a company with sustained lackluster performance may signal trouble ahead, which may prompt us to engage them in constructive dialogue and exercise our proxy voting rights accordingly. We take a measured approach to our shareholder activism — at times, we may determine that an aggressive posture or public response to an event may do more harm than good to the company and shareholder value, in which case our response will be more guarded.
Q: Does it end up having minimal impact?
A: It depends on the company. Some companies ignore their shareholders, often to their detriment, while others listen and respond. We have engaged both General Motors and Ford over the past several years, particularly on the need to produce more fuel efficient cars. GM didn't listen and went through bankruptcy. Shareholders lost everything. The new company is now 80 percent owned by the U.S. and Canadian governments. Ford did listen. The company went through some difficult retooling, but they are now profitable and the value of our investments is moving back up.
Q: How much overall does the state treasurer oversee in state investments? How does the treasurer determine how moneys are invested?
A: The state treasurer, as Connecticut's chief elected financial officer, oversees the investment of the state's pension fund with assets valued at approximately $23.5 billion (as of March 31, 2010). The pension funds are invested in accordance with an asset allocation strategy and guidelines set forth in an investment policy statement that is annually reviewed by the state treasurer and the independent State Investment Advisory Council. Most of the pension funds are invested by external money managers, but I don't make these decisions in a vacuum. We have a chief investment officer and in-house professional staff, as well as outside consultants, that vet all prospective money managers. My decision to hire a manager is based on thorough due diligence which takes into consideration such factors as the manager's investment strategy and its suitability for the pension funds, track record and expertise, and commitment to good corporate citizenship. There is disclosure and transparency throughout my decision-making process, and no contracts are entered into without first seeking and receiving feedback from the Investment Advisory Council. I also look to do business with Connecticut-based firms, in particular, and have an established policy that enables these firms, as well as women and minority-owned firms, to compete and earn some of the Treasury's business.
In addition, the state treasurer oversees the Short-Term Investment Fund with assets of roughly $4.8 billion as of May 21, 2010. The manner in which STIF assets are invested depends on a number of factors, including liquidity needs, current market conditions and expectations for future interest rate movements. STIF's objective is to provide as high a level of current income as is consistent with, first, the safety of principal and, second, the provision of liquidity to meet investors' daily cash flow requirements.
Q: You're a proponent of stockholders having a "say on pay" when it comes to CEO compensation. Is it realistic for stockholders to enjoy this kind of micromanagement?
A: "Say on pay" is not micro-management. Rather, it is an advisory vote that is not binding. What companies need to do is listen to their shareholders' concerns and align pay with performance, set real performance goals, and get rid of poor pay practices such as excessive perks, tax gross-ups and excessive severance agreements. "Say on pay" is a legitimate way to send a message to a board that they are either doing their job well or poorly.
Q: Will this discourage talented CEOs from working for publicly-held companies?
A: If a CEO doesn't want to hear from his or her shareholders, I think there are bigger problems with their management style. Talented CEOs listen to shareholders, employees, customers, and other stakeholders. We talk to many CEOs and especially members of corporate boards of directors. For example, we have had regular dialogues with American Electric Power and EMC over the course of the last seven years. These companies also seek out the views of other investors and stakeholders as well. They listen, and are taking action to face the challenges of tomorrow, not yesterday.
Q: How is the state pension fund doing overall in the recent economy? Has it been battered badly?
A: There are encouraging signs that the worst of the global recession of 2009 may be behind us. Since July 1, 2009, our state's pension funds have realized strong investment performance, returning 19.41 percent through March 31, 2010, as compared with a negative return of 17.3% for fiscal year ending June 30, 2009. Relative to its peers of other large public pension funds over this volatile two-year period, the pension funds' performance is in the 26th percentile. In other words, the funds have outperformed 74 percent of its peers in this very volatile market period, while taking less risk than other top performers. We believe these successful results reflect our ongoing practical investment strategy to position the funds' portfolios for long term growth and financial strength, as well as protect asset values in down markets.
Q: Why does the state's Short Term Investment Fund, a money market of sorts, have such a strong performance average over the past 10 years (July '99 to July '09)?
A: The Treasurer's Short-Term Investment Fund (STIF) is an AAAm rated investment pool of high-quality, short-term money market instruments. It serves as a government investment pool for the operating cash of the State Treasury, state agencies and authorities, municipalities, and other political subdivisions of the state. As of June 30, 2009, STIF had an average compounded annual total return of 3.52 percent for the previous 10 years, versus the benchmark (similar institutional, first-tier rated money funds) return of 3.18 percent. During that period, STIF's above-average performance resulted in an additional $148 million in interest income for Connecticut's governments and their taxpayers.
Principal reasons for STIF's strong performance include effective security selection and successful fluctuations to the portfolio's average maturity in response to the changing interest rate environment. In addition, interest earned on our reserves (which most money funds do not have) is passed on to all investors, adding to STIF's annual return. Finally, our expenses are relatively low. Our historically strong performance provides important incremental income to the state and local government entities that invest with us, thereby helping them deal with their budget issues, ultimately benefiting the state's taxpayers.
We have been able to provide this strong performance through management stability and highly-skilled and dedicated professional staff members who have chosen government careers rather than take their talents to Wall Street.