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Q & A Shaffer

Riding herd over $21.7 billion in assets is Kenneth Shaffer, chief investment officer for the Los Angeles County Employee Retirement Association, commonly called LACERA.

That’s the pension fund for about 75,000 county employees, and 40,000 retirees or people on disability.

A voracious reader with the awesome responsibility of investing billions of dollars, Shaffer sees his task as helping to select the basic allocation model how much to give to bonds, how much to stocks, and how much to real estate and keeping a nine-member county Board of Investments well apprised about performance and opportunities.

Shaffer came to Los Angeles from San Francisco, where he invested public pension funds for city and county employees, and before that Alaska, where he performed the same role for state government workers.

Question. We are seeing other large pension funds, such as California Public Employees Retirement System (Calpers) and Florida’s pension fund, becoming active on issues of corporate governance the make-up of boards, executive compensation, such issues. Is there a role for LACERA in this?

Answer. We are not as large a fund as Calpers (with $200 billion in assets), and cannot afford to do some of the things they do they will actually visit (a corporation’s) management and bring along their own legal counsel. I would have trouble explaining the cost of airline tickets to our boards and beneficiaries. We do vote all of our proxies, in accord with certain corporate governance principles our board has adopted, on such issues as putting independent directors on the audit and compensation committees (of corporate boards), or getting rid of staggered boards (which impede shareholders who wish to vote a board out). We are in between activism and passivity.

Q. If you can’t afford to act like Calpers, could you coordinate with them? Form strike teams, something like that? Share costs, perhaps with them and several other pension funds?

A. Theoretically, it is possible. But we still have to justify allocating trust fund assets, and decide if that is in the best interests of beneficiaries.

Q. Overall, how do you allocate $21.7 billion?

A. We have 57 percent in domestic stocks, and 7 percent in real estate equity (direct ownership). We have 36 percent allocated to the fixed-income (bonds). We have 2 percent (a part of the 57 percent in stocks) allocated to alternative investments (venture capital and other smaller investments).

Q. There is a complaint among some in venture capital circles that LACERA has enormous amounts of money under management, all of it originating from local taxpayers, or locally based employees. But you have no policy of investing it back here in fact, you even allocate money overseas. Is this a valid complaint?

A. Well, Calpers once looked into this, and discovered that companies that might be based elsewhere, such as Microsoft, actually have huge operations in the state. So the money does come back in some sense.

But even more important, our primary obligation is to the beneficiaries, and to pay benefits, and acquire high-quality assets. Our mission is not related to any social policies others may have. I might add that the historical record of state and local pensions doing local investments is not good, and there have been cases of cronyism, or elected officials using pension funds to subsidize pet projects. Who decides what local investments get funded?

Q. I understand you are not a fan of real estate investment trusts, or REITS.

A. They have higher management costs (than direct ownership of a building), and you have no control. Add to that, you are paying as high as $1.60 or more for $1 worth of property. And maybe that’s going to be 80 cents. I am not an advocate of real estate it has a place in a portfolio, but probably not as a REIT. Besides, we don’t need the liquidity of the REIT. We have very long-term obligations, and thus a long-term horizon. We don’t need to get in and out.

But if you can buy property at the right point in a cycle as we have seen in California it is worth considering.

Q. That raises an interesting question. You have a board you report to, and get approval from, and you have money managers, and huge sums of money to allocate. Can you move quickly enough to take advantage of perceived market trends?

A. There’s no doubt about it, sometimes pension funds move slowly. In the late 1980s I was chief investment officer for San Francisco (city and county’s pension fund), and I remember it took years to decide to allocate money to a category, put out RFPs (requests for proposals), to evaluate managers, and to actually give them the money. If you already have money allocated to managers in an assets catagory, you can move a lot more quickly; it can be a matter of months, not years.

Q. LACERA seems to have a plethora of money managers. You have hired 25 stock and bond managers, a half-dozen real estate managers, and some other smaller managers, and you spent about $45 million a year in fees. A lot of academic studies show that managers cannot consistently outperform the market. Indeed, with institutions so heavily in the market thse days, they are the market. At some point does it make sense to just put the money in index funds?

A. I always think we have too many managers. But there are constraints as to how much you want to give to one manager. You want to diversify. But the more managers you have, the less time you can spend on each manager the span of control gets stretched. When it gets to alternative investments, we are in 45 limited partnerships.

And it is true, beating the market is hard. But if a manager cannot beat the market, why have them? But to gauge that, I think you have to let them manage through at least one full market cycle although this (current) cycle is going on (a long time). … We have about one-third of our funds in passive, indexed funds. I still think we can find a dozen domestic managers of equities who can beat the market, although it gets tougher as you get larger.

Q. What is the worst investment that LACERA ever made?

A. I don’t know if I can point out the worst, but one of the worst types was “co-mingled real estate funds.” This was a hot idea 10 to 15 years ago. Very disappointing results. These things were really designed to bring fees to their managers, not returns to investors. You didn’t have control over what was going on. Managers earned fees for buying and selling properties, not getting a return for investors. Now, we make sure our financial interests, and those of the managers, are aligned.

Q. And what is the best investment?

A. Ironically, also real estate. We bought the Huntington Ritz Carlton (hotel) in Pasadena, several years back, from the Japanese lender who had foreclosed on the Japanese developer. They had more than $100 million in it. We bought it mid-forties (about $45 million), and now we have been told it is worth at least $90 million. That’s certainly been a winner for us.

Q. What looks interesting now?

A. Well, high-yield bonds are an asset class we are getting into, although I wish we had been in already. In San Francisco, they have done splendidly with them.

Q. What words of wisdom do you have for us ordinary investors?

A. The market will humble you. I have been at this 22 years, and I feel like I am still learning. If anyone tells you they know what is going on, mostly likely they just want to reach into your pocket. I have told our (investment) board that it is not going to be all up, there can be slow years, and even down years. Of course, we are up (on the S & P; 500) 17 percent this year already.

But that’s the great thing about this job: it never gets boring. I literally have to try to understand the world, its politics, its business, its economics. There is always something more to learn.

Kenneth L. Shaffer

Employer: Los Angeles County Employees Retirement Association (county pension fund)

Position: Chief Investment Officer

Born: 1948, Minnesota

Education: University of Minnesota; BA, MBA

Hobbies: Bridge, recreational computers, reading

Career turning point: Becoming chief investment officer in 1989 for the city and county of San Francisco

Personal: Married, one daughter

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