NEW YORK UNIVERSITY ROBERT F. WAGNER GRADUATE SCHOOL OF PUBLIC SERVICE P INVESTMENT MANAGEMENT IN THE PUBLIC AND NONPROFIT SECTORS January 2015

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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 2015 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, 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. PREREQUISITE P Financial Management TEXT AND READINGS Text David F. Swensen, Pioneering Portfolio Management: an Unconventional Approach to Institutional Investment, Free Press, Please use the 2009 edition of this book. The text is also available as an ibook and on Kindle; chapter numbers are noted in the reading assignment. Investment Management in the Public and Nonprofit Sector Page 1

2 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 case study on the Hewlett Foundation and a 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. The case study is available for purchase online from Harvard Business School (See link in the Lecture 2 readings). 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 13, Memo 2 is worth 50 percent of the course grade and is due on January 23 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 6, 2015, 2:30-5:30 PM) Typology of assets: real, financial, derivative Characteristics of assets (Historical returns, volatility, correlation) Investment Management in the Public and Nonprofit Sector Page 2

3 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 o Real estate, real assets, commodities o Gold o Currency management Key financial concepts: present value, future value, compound interest, measuring rates of return Reading Howard Marks, All that Glitters, Memo to Oaktree Clients [December 2010]. David F. Swensen, Pioneering Portfolio Management: an Unconventional Approach to Institutional Investment, Free Press, 2009, pages (Chapters 7-8); (Appendix). 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. 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. Lecture 2 (January 8, 2015, 2:30-5:30 PM) Characteristics of assets (Continued) Investment Management in the Public and Nonprofit Sector Page 3

4 o Private equity o Hedge funds 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 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 Cambridge Associates, An Overview of Hedge Fund Strategies and Operations, Document provided with permission of Cambridge Associates; it should not be distributed or copied. 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 David F. Swensen, Pioneering Portfolio Management: an Unconventional Approach to Institutional Investment, Free Press, 2009, pages (Chapters 1-6); (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 Investment Management in the Public and Nonprofit Sector Page 4

5 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. Optional Readings 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 Luis M. Viceira and Helen H. Tung, Investment Policy at the Hewlett Foundation (2005), Harvard Business School, PDF-ENG, January 26, Available from (for a fee) URL for case study is: Lecture 3 (January 13, 2015, 2:30-5:30 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 Director ownership of securities o Mutual funds o Limited partnerships Models for managing assets o Investment committee o Internal staff management o Outsourced Investment Management in the Public and Nonprofit Sector Page 5

6 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 Attorney General of the State of New York, In the Matter of the Markstone Group, Assurance of Discontinuance, February This is among a number of settlements in the New York State Comptroller pay-to-play scandal. The document generally describes the self-dealing that took place. JOSEPH E. MCDERMOTT, &C., ET AL., RESPONDENTS, v. EDWARD V. REGAN, &C., ET AL., RESPONDENTS, AND STATE OF NEW YORK, APPELLANT. / AND TWO OTHER ACTIONS: GUZDEK V. REGAN AND PUMA V. REGAN. 82 N.Y.2d 354, 624 N.E.2d 985, 604 N.Y.S.2d 890 (1993). November 16, This is a NYS Court of Appeals decision concerning a legislative attempt to require that the trustee of New York s pension fund use a specific actuarial method; the Legislature took this action to balance the State s budget. The decision is a real-world example of the pressure that public pension funds face during periods of fiscal stress. (This document is in NYU Classes under Guzdek v. Regan ) Memorandum from Michael Green, Director of Alternative Investments, Texas Teachers Retirement System to board member Linus Wright [October 2010]. This memo was written by a former staff member of a major public pension plan; it describes a number of conflicts among fund managers, consultants, staff and trustees. Although the allegations described in the memo have not been substantiated, they are similar to issues that have arisen in a number of U.S. pension funds. 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 6

7 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. Sam Howe Verhovek, Regan Attacks Proposal to Reduce State Payments to Pension Funds, New York Times, April 20, New York State Insurance Department, REPORT ON EXAMINATION OF THE NEW YORK CITY EMPLOYEES RETIREMENT SYSTEM AND NEW YORK CITY PUBLIC EMPLOYEES GROUP LIFE INSURANCE PLAN, June 25, Page 2, 15-17, 28-31, 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 3. Assignments Memo 1 due at beginning of class. Lecture 4 (January 15, 2015, 2:30-5:30 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. Investment Management in the Public and Nonprofit Sector Page 7

8 David F. Swensen, Pioneering Portfolio Management: an Unconventional Approach to Institutional Investment, Free Press, 2009, pages (Chapter 10). Alice H. Munnell, Should Public Plans Engage in Social Investing, Center for Retirement Research at Boston College, August Discussion of recent public pension plan efforts to divest investments for social policy. 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 lecture 4 discussion document New York State Common Retirement Fund, DiNapoli Announces Program for Sudan Divestment, press release dates June 11, California Public Employees Retirement System, Sudan Related Investments Second Legislative Report, December 31, Focus you reading on the first two pages of the report; what is the process CalPERS is using to determine whether to divest? 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. January 23, 2015: Memo 2 due by 5:00 PM via . Investment Management in the Public and Nonprofit Sector Page 8