Paying for Performance

by | Sep 5, 2008 | Weekly Column | 1 comment

rapid-city-journal-2.jpgIn an August 27 editorial, the Rapid City Journal questioned the bonus given to state investment officer Matt Clark. The editorial raises a good point. Why give a bonus to someone who lost $692 million? Shouldn’t investment performance like that be penalized rather than rewarded?

Before answering that question, I need to disclose that I served on the South Dakota Investment Council from 1998 to 2003. It was an honor to participate in managing the South Dakota Retirement System, which is one of the most successful in the nation.

I would suggest that the $147,178 bonus paid to Mr. Clark was completely reasonable when we look at all the facts and consider two key factors. One is the overall returns the SDRS has earned compared to the average or benchmark return. The second is how financial professionals are compensated.

First, let’s compare returns. In the fiscal year that ended June 30, 2008, the average manager (the capital markets benchmark) lost 4.20%. The SDIC lost 8.65%, under-performing the average by 4.45%, clearly a bad year. Because one-third of Mr. Clark’s bonus is based on the fund’s one-year performance, he received no bonus for the last fiscal year. This is understandable and reasonable. The Journal is right that rewarding under-performance does not make sense. Nor is it the policy of the SDIC or the state legislature.

However, all markets have down years and even the best investment managers have losing years. An asset allocation similar to that of the SDRS will have annual returns that fluctuate between -20% and +35%. Every fourth or fifth year may typically show a loss. To be fair to Mr. Clark and his staff, we need to take a broader look.

Over the four years ending June 30, 2008, the average investment manager earned 8.13%. The SDIC earned 9.19%, an over-performance of 1.03%. Even with the one bad year, Mr. Clark and his team have earned an man-holding-bonus-money.jpgextra $249 million for the state’s retirees over the past four years. Two-thirds of Mr. Clark’s bonus is based on the rolling four-year return. This is because the state legislature correctly believes one of the keys to investment success is its focus on the long term. It was for his four-year over-performance that Mr. Clark earned a $147,178 bonus.

In relation to the amount he earned for the retirement fund, Mr. Clark’s bonus probably is unreasonable—he should have been paid more. This is especially true when you consider the SDRS is in the top 1% of all public plans over the last 25 years. Over $1 billion extra has been added to the state retirement system since inception, $600 million of that over the past 10 years.

The Journal argues that the state “shouldn’t be subsidizing one profession over others with high pay.” This argument makes no sense, suggesting the governor should earn the same salary as someone mowing highway ditches. Jobs, such as managing investment returns on the retirement accounts of 70,000 South Dakotans, require more education than many other state jobs and deserve more compensation.

The Journal also “doesn’t buy” the fact that the state’s investment professionals could earn more in the private sector. The last compensation study done for the SDIC found its employees are earning 30% less than what they could earn in comparable positions in the private sector. The success story here is that, even paying under-market salaries, the state has managed to retain top investment talent, which has paid off fabulously.

The outstanding long-term performance of the SDIC demonstrates that attracting and keeping skilled professionals by paying them fairly is a wise investment for the retirees of our state.

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