Pay for performance? Why Oregon pension managers can earn more even when investments lose money

In 2022, Oregon’s public pension investments lost 1.55% of their value, the worst performance since the financial crisis in 2008 and one that tacked $6.6 billion on to the system’s already enormous funding deficit.

But for the pension fund’s investment managers at the Oregon Treasury, already some of the best paid public employees in the state, it was a banner year. On average, they earned their biggest incentive payments in years: 29.2% of base pay, out of a possible 30% target.

The resulting $147,187 incentive payment for Rex Kim, the chief investment officer, boosted his total pay to $663,271. Michael Langdon, then the director of private markets investments, received $123,105, lifting his total pay to $533,459.

Even the most junior investment officer got a $30,681 incentive payment, bringing her pay to $134,649.

Rewarding staff when the pension fund is losing money may sound ludicrous to some. But Oregon’s incentive system, built on a somewhat complicated formula, factored in performance from past years and effectively celebrated that bad year by concluding losses could have been far worse.

That explanation doesn’t sit well with folks like Ali Lanenga, who started digging into the pension system’s economics after joining the board of the Riverdale School District. She said supposedly “historic” school investments by lawmakers are being diverted from the classroom to pay unfunded pension liabilities that can be attributed in part to lousy investment returns.

“What performance are we incentivizing? If a bonus is paid, it should be for reducing the deficit, not expanding it,” she said in an email. “These bonuses are a symbol of a systemic disconnect and must be justifiable to taxpayers who fund them. The state should align executive rewards with public interests.”

Officials at the Oregon Treasury contend that’s exactly what they’re doing. They say the investment officers’ compensation structure is designed to attract and retain experienced professionals to manage the $97 billion pool of investments and align their pay with performance – both qualitative and quantitative. The incentive compensation, they say, is based on an objective process run by an internal committee comprised of its human resources director, general counsel and deputy treasurer, none of whom receive incentive compensation.

Treasury’s compensation structure isn’t out of line with other large state pension systems, a review by The Oregonian/OregonLive found. And the compensation committee has applied its incentive formula as designed over the past five years, according to public records reviewed by the newsroom.

In fact, incentive pay at Treasury’s Investment Management Division isn’t tied to the fund’s absolute returns, which is what ultimately matters to taxpayers, workers and the health of the pension fund. Nor does it depend on financial results in any given year, or the returns from the particular bucket of investments staff manage.

Instead, what matters most is the pension fund’s overall performance over the trailing five years relative to an internal financial yardstick – called a benchmark – that Treasury, its consultants and the citizen panel that oversees the investments use to gauge the pension fund’s performance against a composite of broader stock and bond market indexes. The formula historically also ranked Oregon’s retirement investment returns against other large pension systems, a factor it eliminated starting this year.

Staff were paid the big bucks in 2022 because the pension fund lost less money than that yardstick. A lot less, it turns out, because the stock market had something of a meltdown that year, while Oregon’s pension investments held up better. That’s mostly because they’re heavily influenced by returns from so-called alternative investments such as private equity and real estate, which aren’t publicly traded and were less volatile. The smaller loss in 2022 contributed to a better overall performance relative to the benchmark over the five-year period in question, and relative to what other state pension funds delivered, which is what most of the incentive calculation was based on.

Qualitative performance of the investment officers matters, too, including factors such as teamwork, integrity, communication and critical thinking. It accounts for a third of the incentive compensation formula. And as a group, they’ve garnered very high scores in the last four years, between 8.7 to 9.2 out of 10 on average, even when the pension fund’s investments were delivering decidedly mediocre results.

To be fair, it’s not a bonanza every year. Treasury targets incentive compensation at 30% of base pay each year, then deducts points when the fund underperforms. In 2021, when the pension investments delivered returns of 20%, the incentive payments were significantly reduced because the 5-year average return was below its policy benchmark and performance lagged against other funds. The same happened last year, an unexceptional year for the fund, overall and relative to the benchmark.

That raises the question of whether the benchmark Treasury has set in place is an accurate proxy for what its investments, and its investment officers, should be able to achieve given the investment mix they’ve put together. It’s a topic of some controversy in the wider investment community, as choosing the right benchmark is a subjective process.

Richard Ennis, a longtime consultant to large institutional investors, concluded in a 2023 paper in The Journal of Investing that large public pension funds and endowments were routinely biasing their benchmarks downward, meaning they tend to represent a less than fair return for the market exposures and risk being taken.

Oregon’s benchmark, he said in an interview, was “an especially slow rabbit” in his analysis, generating annual returns more than 2 percentage points below what he contends a more accurate benchmark would have yielded.

Treasury spokesperson Eric Engelson said in an email the agency is committed to transparency in how it reports performance and benchmark data. He said the agency posts the performance of its investments alongside benchmarks for each asset class as well as one that reflects a passively invested portfolio of 68% stocks and 32% bonds. He noted Oregon’s 10-year annualized return was 7.6%, beating both its internal benchmark and its long-term earnings assumption of 6.9%, “demonstrating strong long-term results for beneficiaries.”

Either way, Treasury’s general approach to incentive compensation is not out of line with many other large state pension funds.

A survey by the National Conference on State Retirement Plans found that 71% of state plans with more than $60 billion in assets offer bonuses or short-term variable pay to staff.

Likewise, the National Association of State Retirement Administrators found in a 2022 survey that up to half of chief investment officers managing statewide systems are eligible for some form of incentive compensation.

“It’s probably safe to assume that if the CIO is getting it, their staff is eligible, too,” said Keith Brainard, the organization’s director of research.

The actual compensation schemes for state investment officers vary in their specifics, as does their approach to investing. Nevada PERS, for instance, pursues a barebones, low-cost investment strategy heavily focused on publicly traded stocks and bonds that has yielded superior returns over the last decade. The $65 billion system has only two investment officers, and according to a database maintained by Transparent Nevada, the most recent salary for the chief investment officer was $152,610 in 2019, with no incentive pay. Nevada officials this week didn’t respond to requests for newer salary and incentive data.

California and Virginia, by contrast, are large state pension plans and, like Oregon, are active investors. That means they try – sometimes successfully – to deliver superior returns to the broader market by building complex portfolios with exotic investments that require larger, more sophisticated investment teams to manage them.

The California Public Employee Retirement System, which is five times the size of Oregon’s, shifted its compensation plan last year to heavily emphasize incentive pay over base salary. It’s incentive payments for investment staff now range anywhere from 10% to 150% of base pay depending on seniority.

To retain staff, those incentive payments have a short- and long-term component. The former are based on the fund’s 3- and 5-year returns versus an internal benchmark, and the latter on the system’s absolute performance against its overall earnings assumption, currently 6.8% a year.

Likewise, Virginia offers investment officers incentive payments ranging from 10% to 70% of base pay, according to an incentive plan posted on its website. But it bases the quantitative portion on both the absolute returns of the total pension fund as well as the performance of the investments that individual investment officers are responsible for.

Washington’s State Investment Board, by contrast, doesn’t offer annual incentive payments at all. By statute, it limits investment officer compensation to the average total compensation of peer pension funds of similar size, and it reevaluates the cap every other year through a salary survey process, according to James Aber, a spokesperson for the agency.

Brainard, the research director for the National Association of State Retirement Administrators, said the compensation of state investment officers is debated around the country, but lost in the conversation is that employee retention is an issue that state plans struggle with. The continuity can be critical to performance, but many employees can and do leave for the private sector or an endowment, where they can earn more while managing significantly smaller pools of money.

“While these salaries appear high, they are immaterial in terms of their effect on the performance of the funds,” Brainard added, referring to how little state plan compensation, which is typically drawn from the pension fund itself, impacts returns.

There is research, however, that suggests a positive correlation between higher compensation for chief investment officers at public plans and improved investment performance.

Kevin Mullally, a finance professor at the University of Central Florida, co-authored a 2022 study that found higher paid chief investment officers outperform their lower-paid counterparts, largely through increased and superior performance in private equity and real estate investments, two areas where Oregon is heavily invested.

The study didn’t find any direct link between performance and the availability of incentive compensation, he said. But tying pay to performance can make it more politically acceptable.

“They are fighting for talent in an industry that pays a lot of money,” he said. “$600,000 is a number that could strike you as outrageous. But if you hear at least some of it is based on performance, it’s a bit more palatable.”

—Ted Sickinger is a reporter on the investigations team. Reach him at 503-221-8505, tsickinger@oregonian.com or @tedsickinger