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May 29, 2023 Editor’s Take

Bordonaro: CT pension fund investments need greater oversight

Greg Bordonaro

Jeffrey Sonnenfeld, the senior associate dean for leadership studies and a professor at Yale University’s School of Management, is known for his provocative research.

Last year, shortly after Ukraine was invaded in February, he published a list of U.S. companies doing business in Russia, putting pressure on them to exit the country or face potential public backlash.

His work drew attention from major U.S. media outlets, including the New York Times, Wall Street Journal and Washington Post, and likely forced some companies to publicly declare they were at least temporarily severing business ties with or in Russia.

His latest Connecticut-based research is just as compelling, and downright disturbing, and should provoke similar calls for action from local media, taxpayers, the business community, state policymakers and others.

In a recent comparative analysis of state pension fund investment performances, he and fellow researcher Steven Tian concluded that “previous treasurers provided this state, consistently, with one of the single worst investment track records” in the country, costing Connecticut billions of dollars in returns that could have significantly improved the pension fund’s funding status and/or led to tax cuts.

“While the legislature battles over thousands of dollars or even millions of needed expenditures, billions of dollars were lost on terrible investments — investment errors that 49 other states somehow avoided,” the two researchers wrote in an op-ed recently published by Hearst Connecticut newspapers.

They added: “With $40 billion in assets — largely the pooled retirement savings of the state’s hardworking teachers, firefighters and public employees — if Connecticut’s investments had yielded just the median returns of all 50 states, the past five years, we would have had $5 billion more and be able to cut taxes by 50 percent instead of 0.5 percent. Connecticut would have reaped a whopping $27 billion more over the last decade — practically enough to fully fund Connecticut’s pension obligations while simultaneously dramatically reducing taxes.”

Yale School of Management Chief Executive Leadership Institute

As of June 30, 2022, Connecticut had the second-worst pension fund returns of any state in the nation on a three-year and five-year annualized basis, and the fifth-worst performance on a 10-year basis, according to Sonnenfeld and Tian.

Only North Carolina performed worse — a startling realization for a wealthy and highly educated state that, ironically, prides itself on having a strong financial services sector.

The researchers lay blame on two major factors: unusual asset allocation decisions and widespread external investment manager underperformance.

They point out that “Connecticut has made some highly costly and unusual asset allocation decisions over the past decade,” including underinvesting in private strategies like real estate, and over investing in areas like low-grade emerging-market and high-yield bonds.

If past treasurers had simply adopted “a generic 60/40 portfolio” (meaning 60% stocks and 40% bonds), it would have outperformed Connecticut’s actual performance by over 1% annually, they concluded.

They also identified numerous private investment managers hired by the state that charged exceedingly high fees but delivered subpar results. Some funds actually lost money, while many others produced returns below average benchmarks.

Sonnenfeld and Tian recommend the state establish a more basic investment portfolio that focuses on getting into “top-tier blue-chip funds with strong, established track records of success.”

Just as important, better checks and balances must be built into the investment decision-making process.

Connecticut, Sonnenfeld told me in a recent interview, is one of only two U.S. states that makes its treasurer the sole fiduciary. The state’s Investment Advisory Council — a seven-member board that includes five members of the public appointed by the governor and legislative leaders — is purely a consulting body without oversight powers.

Forty-seven other states vest fiduciary duty in an elected or appointed board, Sonnenfeld said.

The only other state with a similar model to Connecticut’s is, you guessed it, North Carolina, which is currently considering moving toward a stronger board oversight structure.

Connecticut must do the same. The status quo, based on Sonnenfeld and Tian’s research, isn’t working and is hurting Connecticut’s economic competitiveness.

“It’s good to have a board of directors that has some teeth, that can challenge you, and can override you if need be, and right now we don’t have that,” Sonnenfeld said.

Making that shift would require legislative approval, and there could be some support around the idea.

Yale School of Management Chief Executive Leadership Institute

State Senate Minority Leader Kevin Kelly (R-Stratford) said he views Sonnenfeld’s report as a call to action.

“I believe you want the Investment Advisory Council to have more oversight,” Kelly told me, adding he hopes a bill is written up and considered before the end of the legislative session on June 7.

Both Sonnenfeld and Kelly pointed out that current State Treasurer Erick Russell isn’t to blame for past investment strategy failures. He’s only been in office since January, after winning election last November.

But he will have the power to shift Connecticut’s investment strategy moving forward, and changes can be made almost immediately, Sonnenfeld argues.

Economic competitiveness issue

Sonnenfeld said he approached his research from a nonpartisan perspective. He noted he’s longtime friends with both Democratic Gov. Ned Lamont and businessman and two-time GOP gubernatorial candidate Bob Stefanowski.

In September 2021, Sonnenfeld was also named co-chair of AdvanceCT, a private economic development agency responsible for recruiting companies to the state and improving Connecticut’s economic competitiveness.

It’s from that vantage point that he wanted to take a closer look at the state’s pension fund performance, which has a direct impact on Connecticut’s budget and fiscal health.

He said he remembers an economic summit he organized years ago, where top Connecticut business, political and other leaders gathered to discuss the state’s challenges in the wake of General Electric’s announced plans to relocate its headquarters from Fairfield to Boston.

The state’s fiscal instability and unfunded pension liabilities were top-of-list concerns, including state policymakers’ unwillingness to address them.

Sonnenfeld’s research indicates that a lackluster investment performance is also a driver of the state’s longer-term fiscal issues, something that is fixable.

State lawmakers and Connecticut’s new state treasurer must heed his warnings and recommendations.

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