Game Plan | Published in July 1996

New Order

Massachusetts Prepares for PRIM/MASTERS merger

By PS | July 1996

Big Massachusetts funds prepare to unite, set new investment options for local plans

Massachusetts Treasury officials are making swift progress on two projects they hope will together make the state pension system more efficient and effective. Under new regulations, the Bay State's 104 local retirement systems can now invest through the Pension Reserves Investment Management fund according to their own asset allocations, rather than PRIM's. And in late June, the Treasury persuaded Governor William Weld to veto an implementation plan that would have delayed the eventual merger of PRIM and the $8.5 billion Massachusetts State Teachers and Employees Retirement System.

PRIM was created as a flagship investment vehicle for Massachusetts towns and counties. The $7.5 billion superfund designed the new cafeteria-style investment system, which Treasury officials will begin actively marketing this summer, as a way of attracting more local funds, says Executive Director Gregory White. Local boards can now use the PRIM asset mix, choose more or less of certain categories, or only invest in certain asset classes.

Winning approval for the new regulations was an 18-month battle for Treasurer Joseph Malone and his lieutenants as they crusade to overhaul the Massachusetts state pension system. And gaining approval for the merger required overcoming a go-slow agenda pushed by State Senate Democrats, who wanted a five-year impact study to be performed first.

Investing through PRIM offers local governments economies of scale, plus significantly reduced paperwork with the state's pension watchdog, the Public Employee Retirement Administration. But one key problem from PRIM's inception in the mid-1980s was that local systems had to adopt PRIM's asset mix, which was sometimes at odds with their own goals. The Norfolk County Retirement System, an early PRIM advocate, had a disproportionate number of employees in high-risk professions-police and firefighting-and thus set goals that required a more aggressive asset mix. When Norfolk concluded in 1992 that it should have more of its assets in US equities than PRIM was providing, it had to pull out.

Other local investors shrank away when unwise and indiscriminate real estate and alternative investments tanked in the early 1990s, sending PRIM's performance numbers-respectable in the long term-into a tailspin. Promised state-subsidized bonuses for signing a five-year agreement to invest through PRIM began to peter out and eventually disappeared from the budget. And local fund administrators, running scared of perennial, often unsuccessful, legislative attempts to reduce the influence of local governments, feared PRIM would eventually take over all local retirement systems.

The result is that today PRIM only manages assets for 27 fully or partly participating local systems-a number that has remained roughly the same for the past five years. Local funds comprise about $500 million of PRIM's assets.

Recordkeeping is critical to the success of the ˆ la carte system. PRIM officials and their custodian, State Street Bank & Trust, devised a new program that breaks down operating costs and returns by asset class, so that the fund can prorate investment returns and management fees to local systems.

The new system also separates recordkeeping for the PRIM core-the funds it invests for the state, and for those funds that embrace the PRIM asset mix-from the ˆ la carte portfolios. This way, substantial investment in international equities by local funds, for example, will not end up overweighting PRIM's overall commitment to the asset class.

Segmented accounts in US and foreign stocks and bonds will be available later this summer, White says. A la carte accounts for alternative investments and real estate-difficult to quickly value, and therefore hard to fit into the recordkeeping system-will be available later.

Norfolk County Treasurer Robert Hall, who oversees the county's $250 million retirement fund, says he hopes this will be sooner rather than later: He wants to consider hiring PRIM to manage a $5 million alternatives mandate he is looking to fund before fall. "I've been advocating PRIM do this ever since there was a PRIM," he said. "It opens a world of investment opportunity for smaller funds."

Florence Pires, executive secretary for the $120 million Fall River Contributory Retirement System, agrees. Fall River's board members will consider using PRIM to fill their non-US equity assignment, she says, because the superfund could offer a cheaper rate than most managers would for a commingled portfolio. PRIM has significantly improved its performance since 1992, in part through hardball negotiating and wider implementation of performance-based fees which have helped it to cut its average operating costs from 62 basis points to 41 (see "Cinderella Story," Plan Sponsor, May 1994).

Merger mania

With the cafeteria system now installed, PRIM officials turn to their next challenge-merging the fund with MASTERS. "We should have never had a second pension fund," says Malone, a Republican who is quick to mention that his Democratic predecessors built PRIM. The treasurer argues that combining staffs and portfolios could save as much as $15 million in annual operating costs.

Earlier this year, the state House of Representatives approved a state budget that included enabling legislation for the merger. But the Senate's version would have required MASTERS and PRIM to submit an implementation plan to the Senate and place at least $5 million in cost savings from consolidation into a separate Pension Adjustment Fund.

The adjustment fund would allow legislators to see the captured savings-and perhaps use them to help fund cost-of-living increases in the state's 40-year liability funding schedule. But Malone said the Legislature was not clear on what it would do with the fund, and accused Senate Democrats of foot-dragging. Governor Weld agreed, and last month used the line-item veto to kill the implementation plan. The full Legislature is now expected to vote on the bill, without this provision, in the fall, and Weld has said he will block any attempts to derail the merger.

Meanwhile, MASTERS and PRIM are already taking steps to ease the switch to a combined fund. They now share the same general consultant, Wilshire Associates. Both use State Street Bank as custodian, for a joint annual fee of $700,000. The funds have compatible information systems. And officials successfully lobbied the state to permit securities transfer between the two funds, eliminating significant liquidation and repurchasing costs.

MASTERS has turned over its real estate and alternative investment portfolios to PRIM, eliminating the need for dual sets of consultants for those asset classes. And both funds have openly communicated and worked together to slash their operating costs and improved performance: "We're doing more and it's costing less," says First Deputy Treasurer Thomas Trimarco, who directly oversees MASTERS.

If the two funds are joined into a $16 billion statewide scheme, local funds could still invest as they currently do in PRIM, White says. While the potential makeup of a united fund is still under construction, officials have chosen a target asset mix (see chart).

But they have yet to determine staff composition, or who would be chief investment officer of the combined fund. The two funds currently employ a total of 20 staff, but many MASTERS employees already share duties with PRIM or Treasury. The consolidated staff will likely total about 16 people, says White.

Malone, White, and Trimarco all point out that merging the funds would be a winning move for taxpayers and pensioners. The losers in the deal would be some of the 50-plus investment managers who now serve the funds. Officials agree that no more than 40 of those would survive consolidation.