NEW YORK UNIVERSITY ROBERT F. WAGNER GRADUATE SCHOOL OF PUBLIC SERVICE P INVESTMENT MANAGEMENT IN THE PUBLIC AND NONPROFIT SECTORS January 2017

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1 NEW YORK UNIVERSITY ROBERT F. WAGNER GRADUATE SCHOOL OF PUBLIC SERVICE P INVESTMENT MANAGEMENT IN THE PUBLIC AND NONPROFIT SECTORS January 2017 INSTRUCTOR Nick Smirensky (917) (Mobile) Office hours: Prior to class (please let me know so I can arrive early), after class, or by appointment. If you have questions between class meetings or on assignments, please feel free to send me an . I will respond to the entire class if appropriate. OVERVIEW This course is designed to provide students interested in careers in state and local government, not for profits, endowments, and foundations with a basic understanding of institutional investment management. With the key concepts covered in this class (portfolio construction, the risk and return characteristics of major asset classes, due diligence, investment decision making, and fiduciary responsibility), students will be equipped to understand the operations of an institution s investment pool as well as evaluate investment and governance policy issues. The class meets five times: January 3, 5, 10, 12, and 17. PREREQUISITE P Financial Management TEXT AND READINGS Text Institutional Investment, Free Press, Please use the 2009 edition of this book. The text is Investment Management in the Public and Nonprofit Sector Page 1

2 also available as an ibook and on Kindle; chapter numbers are noted in the reading assignment. Note that the book is dated, but it is the best text on investment management for a general audience. Readings With the exception of the report from Cambridge Associates, all of the readings are in the public domain. Electronic copies of public domain documents and the Cambridge Associates report will also be available on NYU Classes. I created an Investment Glossary file that contains definition of common investment jargon. Use it as a reference, but it s even better to ask me to explain something that you don t understand. Optional Readings I have noted a number of optional readings. These suggestions are designed for students who wish to pursue more detail in certain subjects. You are not expected to review any of the optional material. GRADING 80 percent Two five-page, double-spaced memos. Memo 1 is worth 30 percent of the course grade and is due at the beginning of class on January 12, Memo 2 is worth 50 percent of the course grade and is due on January 25 at 5:00 PM and should be submitted via . Please note your box number on the memo if you would like it returned. 20 percent Class participation. A case study or article will be assigned for each lecture for class discussion. Approximately 30 minutes of class time for each lecture will be used for each case or article. Class participation during lectures will also be evaluated as part of your grade. ACADEMIC INTEGRITY You are expected to be aware of and follow NYU/Wagner s academic code. CLASS SCHEDULE AND READINGS Lecture 1 (January 3, 2017, 1:30-4:30 PM) Overview of investing Investment Management in the Public and Nonprofit Sector Page 2

3 Typology of assets: real, financial, derivative Characteristics of assets (Historical returns, volatility, correlation) o Public equities (geography of issuance, market capitalization, growth versus value, emerging versus developed markets) o Fixed income (Treasuries, TIPS, corporate, mortgages, asset backed securities); understanding and measuring credit risk and interest rate risk o Cash equivalents Key financial concepts: present value, future value, compound interest, measuring rates of return Reading Institutional Investment, Free Press, 2009, pages ix-xxii, 1-8, (Introduction, Forward, Chapters 1, 7); (Appendix). Mark Brunnermeier and Martin Oehmke, Bubbles, Financial Crises, and Systemic Risk, Section 2: A Brief Historical Overview of Bubbles and Crises. Blackrock Investment Institute, Risk and Resilience: Patterns in Equity Returns, September This is a good, basic discussion of what drives equity returns and how to construct an investment portfolio. U.S. Securities and Exchange Commission, Interest Rate Risk: When Interest Rates Go Up, Prices of Fixed-Rate Bonds Fall, SEC Pub. No. 15, June Optional Readings Zvi Bodie, Alex Kane and Alan Marcus, Essentials of Investment, McGraw Hill. This is a good introductory text for students who want information that goes beyond the content of this class; used copies of older editions are inexpensive. You are not expected to read this. J.P. Morgan, Guide to the Markets: 4Q This slide deck is prepared quarterly by J.P. Morgan; it contains a summary of key economic and market indicators. It s worth paging through this document. Discussion article Howard Marks, Hemlines and Investment Styles, Memo to Oaktree Clients, [September 2010]. I will post issues for class discussion on NYU Classes prior to class. Investment Management in the Public and Nonprofit Sector Page 3

4 Lecture 2 (January 5, 2017, 1:30-4:30 PM) Characteristics of assets (Continued) o Real estate, real assets, commodities o Gold o Currency management o Options o Private equity o Hedge funds Readings Institutional Investment, Free Press, 2009, pages 9-98, (Chapters 2-5, 8) Howard Marks, All that Glitters, Memo to Oaktree Clients [December 2010]. Goldman Sachs, Global Macro Research, All About Bitcoin, March 11, 2104 Cambridge Associates, An Overview of Hedge Fund Strategies and Operations, Document provided with permission of Cambridge Associates; it should not be distributed or copied. Discussion Topic Bitcoin and gold; read the Howard Marks piece on gold and the Goldman Sachs research report on Bitcoin. How do gold and bitcoin function as investment vehicles? How they differ from each other and from other securities? Do either have a role in an investment portfolio? Lecture 3 (January 10, 2017, 1:30-4:30 PM) Overview of the institutional investing environment o Investors: sovereign wealth funds, public and corporate pension plans, endowments, foundations, family offices o Consultants: general and specialized asset classes o Investment managers: banks, specialized firms, partnerships o Internal investment staff o Custodian banks Investment Management in the Public and Nonprofit Sector Page 4

5 The role of investment assets in the operation of endowments and foundations; spending levels Fiduciary obligation: the prudent person and prudent investor standards Documenting the investment policy: elements of an investment policy statement Behavioral finance: overview of cognitive issues that affect the investment process Alignment of interest: managing conflicts of interest and agency risk Regulatory environment: state not-for-profit corporation laws; financial market regulators; SEC, IRS, ERISA Taxation The investment horizon: spend down, perpetuity, funding specific liabilities Intergenerational equity Defining investment objectives through the investment policy statement Readings The Commonwealth Fund, Rethinking the Management of Endowments and Foundations, 2009 Annual Report. This document contains a good discussion of the different models for managing endowments and foundations. Russell Research, Elements of a clearly defined investment policy statement for nonprofits, June Also see sample Investment Policy Statement on Classes. Institutional Investment, Free Press, 2009, pages (Chapters 5-6); (Chapter 9). Shyma Jundi, et al, Behavioral Finance: Applied. The professional Investor s Primer, Essentia Analytics, November This is a good overview of research on the interaction between psychology and investment decision-making. It highlights the need for a structured approach to managing investment portfolios. National Conference of Commissioner on Uniform State Laws, Uniform Prudent Management of Institutional Funds Act, November The commentary provides a discussion of the fiduciary requirements for not-for-profit corporations (endowments and foundations); the same principles apply to pension funds. Perley Fund discussion materials. This file contains information on a significant breach of fiduciary duty at a small New York not for profit. Optional Readings Investment Management in the Public and Nonprofit Sector Page 5

6 Behavioral Finance: feat. Dan Ariely, Richard Thaler, Hersh Shefrin, Terry Odean. Youtube video interview. Robert J. Heuer, Jr, Psychology of Intelligence Analysis, Center for the Study of Intelligence, This is an interesting discussion of cognitive factors that impede intelligence analysis; the discussion is applicable to any discipline. Alexander Ineichen, In Search of Alpha, UBS Warburg, October This provides more details on hedge fund strategies than the Cambridge Associates report. Although it was written in 2000, this report describes strategies used by most of today s hedge fund managers. Tellus Institute, Center for Social Philanthropy, Educational Endowments and the Financial Crisis: Social Costs and Systemic Risks of the Shadow Banking System, [2010]. Read pages 8-31 of this report, which is a relatively balanced discussion of endowment investing. Case study for discussion University Investment Performance Discussion Materials contains data on endowment performance for the fiscal year ending June 30, 2015, discussion questions, and extracts from the annual reports for Yale and Williams College. If there is time available, discuss the issues in the Perley Fund Discussion Materials file. Assignments Memo 1 due at beginning of class. Lecture 4 (January 12, 2017, 1:30-4:30 PM) Asset allocation and portfolio construction : the capital market line, the efficient market hypothesis, the capital asset pricing model Risk management: credit, operational, interest rate, counterparty, liquidity, reputational, financial market Rebalancing Active versus passive management Investment vehicles o Direct ownership of securities o Mutual funds o Limited partnerships Models for managing assets o Investment committee o Internal staff management Investment Management in the Public and Nonprofit Sector Page 6

7 o Outsourced Overseeing performance: comparing risk and returns to benchmarks Public Pension Plans Structuring pension benefits: defined benefit and defined contribution plans Regulatory oversight: SEC, ERISA Governance structures: sole trustee versus board Actuarial funding o Distinction between actuarially funded benefits and pay as you go o Understanding key assumptions: discount rate for liabilities; assumed investment return; inflation and productivity; smoothing returns and liabilities Issues in public pension fund management o Breaches of fiduciary responsibility by pension trustees and staff County of San Diego, State of Connecticut, New York State Common Retirement Fund, California Public Employees Retirement System o Funding public pension liabilities during periods of financial stress Readings Institutional Investment, Free Press, 2009, pages , (Chapters 6, 9). Pension Fund Reading Materials. This PDF contains a set of annotated documents on pension fund issues. Included is material on a 1990 legislative change to New York State s pension funding method; a document from the New York State Attorney General on one of the pay-toplay cases in New York State during the Hevesi administration, a whistleblower memo describing issues at a Texas public pension fund, and an audit by the New York State Insurance Department discussing problems with the New York City pension funds. Alicia Munnell and Jean-Pierre Aubry, The Funding of State and Local Pensions: , Center for Retirement Research at Boston College, June Optional Reading Materials Donald Boyd and Yimeng Yin, Public Pension Funding Practices, Rockefeller Institute of Government, June National Education Associate, Characteristics of Large Public Education Pension Plans, 2010, pp This is an overview of actuarial funding methods for public pension plans. Investment Management in the Public and Nonprofit Sector Page 7

8 Pew center on the States, The Widening Gap Update, June This report discusses unfunded liabilities at the state level for pensions and retiree health care benefits. Jean-Pierre Aubrey and Alicia Munnell, Final Report on Connecticut s State Employees Retirement System, November 2015, executive summary, pages 1-5. This is a good case study on underfunded public pension plans; the factors cited in Connecticut apply in other states, such as Illinois and Rhode Island. Discussion topic Budget and governance issues related to New York State s Common Retirement Fund and the Texas Teachers Retirement System. A 1990 budget action to force the State Comptroller to use specific actuarial assumptions, a 2010 proposal from Comptroller DiNapoli to delay pension contributions, and the pay-to-play scandal during the Hevesi administration will be the focus of the discussion related to New York. A memo from a senior staff member of the Texas Teachers Retirement System will also be used as the basis for a discussion on governance. A background paper and discussion guide will be provided by the instructor prior to class. The file is in NYU Classes under Discussion Paper for Lecture 4 on Public Pensions. Lecture 5 (January 17, 2017, 1:30-4:30 PM) The investment decision-making process o Due diligence o Negotiating terms o The role of staff, consultants, the investment committee and governing body Public policy and investing o Divestment o Economically targeted investment o Program-related investments Reading Alexander Ineichen, The Search for Alpha Continues, UBS Warburg, September 2001, pages This reading describes the investment decision-making process. Institutional Investment, Free Press, 2009, pages (Chapter 10). Investment Management in the Public and Nonprofit Sector Page 8

9 Alice H. Munnell, Should Public Plans Engage in Social Investing, Center for Retirement Research at Boston College, August Discussion of public pension plan efforts to divest investments for social policy. Expanding Philanthropy: Mission-Related Investing at the F.B. Heron Foundation, Southern New Hampshire University School of Community Economic Development. Morgan Stanley, Investing with Impact and Fiduciary Duty, November Divestment Reading Materials and Discussion Topics contains a number of press releases and reports outlining public pension funds approach to divestment. Discussion Topic: The challenge of investing in socially objectionable companies, divestment issues raised by South Africa, tobacco, Iran and Sudan and carbon extracting companies. Refer to Divestment Reading Materials document Optional Reading Rockefeller Philanthropy Advisors, Philanthropy s New Passing Gear: Mission Related Investing, A Policy and Implementation Guide for Foundation Trustees, For students interested in philanthropy, this report describes the use of mission-related investing. Susan N. Gary, Value and Value: University Endowments, Fiduciary Duties, and ESG Investing, February The legal discussion is very useful, and it is much shorter than the 31 pages in the table of contents suggests, given the length of the footnotes. The material in Section IV on investment performance is not as well done; there is much more uncertainty about whether ESG investing has a negative impact on performance. January 25, 2017: Memo 2 due by 5:00 PM via . Investment Management in the Public and Nonprofit Sector Page 9