FROM: Debby Cherney, Chief Executive Officer
SUBJECT: Investment Team Incentive Compensation
RECOMMENDATION:
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Recommend to the Board an updated framework for Investment Officer incentive compensation, effective with FY 2025-26.
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BACKGROUND:
At its April 2, 2015 meeting, the Board approved the Incentive Compensation Plan which included the Chief Investment Officer (CIO) and Senior Investment Officer (SIO) positions as eligible for this compensation. On May 5, 2022, the Board extended the Incentive Compensation Plan to the Investment Officer (IO) classification.
The Current Incentive Compensation Plan Framework:
On June 20, 2024, the Executive Committee reviewed the existing Incentive Compensation Plan. The Chief Investment Officer has a target 50% incentive compensation, the Senior Investment Officers have a target 30% incentive compensation, and if the Investment Officer position were filled, they would have a target 20% incentive compensation. A copy of the current rubric for the incentive compensation for each of those classifications is attached as Exhibit A.
Each award has quantitative elements:
1. Fund Performance
a. Excess return over policy benchmark - a straightforward measure of our fiscal year rate of return (net) vs. the policy index approved by the Board.
b. Absolute return over the stated return - the stated return is currently SBCERA’s assumed rate of 7.25%.
2. Risk Components
a. Alpha generation
b. Sharpe ratio
3. Relative Performance to median public fund universe
a. Risk
b. Return
In addition, each award also has qualitative elements. Among the considerations are:
1. Overall performance evaluation
2. Department management (where relevant)
3. Cohesion with management team
4. Executive of strategic plan and priorities
5. Execution and monitoring of policy
6. Activity and performance in industry groups, representing SBCERA at industry events as a speaker or panelist
7. Learning and growth
8. Board and Committee interactions
Considerations for Potential Changes to the Framework:
The Chief Executive Officer and Chief Human Resources Officer convened the investment officers to discuss potential changes, and subsequently reviewed these principles with the Executive Committee:
1. Our primary goal is to attract, hire, and retain talented investment professionals in order to meet the long-term investment returns demands for SBCERA.
2. The team-based approach should continue. This reflects how the team works as a group, and how relationships with fund managers are handled.
3. The focus should remain on longer-term results, rather than be disproportionately focused on one-year short-term results.
4. Any changes to the quantitative elements of the incentive compensation should retain the focus on measuring absolute performance, relative performance, and risk.
5. NEPC is in the process of developing a new set of benchmarks, which would be a novel concept not yet deployed elsewhere. At present, we hope that these can be implemented in FY 2024-25. If they are implemented as contemplated, and we have confidence in the data and validity of the benchmark, we should incorporate it into the rubric. Further discussion is needed with the team and the Board on whether the existing benchmark, which largely measure asset allocation decisions, rather than manager and/or staff execution, should remain as part of the rubric.
6. Further evaluation is needed on the proportion between the quantitative and qualitative elements of the incentive continue to be appropriate to meet our overall goals. At present, only the qualitative element captures any individual performance.
The Executive Committee concurred that any adjustments to incentive compensation structures would be implemented prospectively.
Implementing Changes for FY 2025-26 and Beyond:
As SBCERA’s Investment program has grown in size, stature, and complexity, we must ensure that we can recruit and retain top talent for the Investment team. With historically tight labor markets, recruiters are actively pulling out top talent from pension systems and new job applicants often have multiple offers to consider. Many investment professionals are attracted to or accustomed to a partial variable pay-for-performance model such as our Incentive Compensation Plan.
NEPC has now implemented its Implementation Benchmark, and staff believes that it should be incorporated as an element in the Incentive Compensation Plan.
In a separate companion item on the Executive Committee agenda for April 23, 2025, staff has recommended the creation of a new classification of “Associate Investment Officer”. The goal is to recruit and retain these associates who can not only make an immediate positive impact on the workload and results of the team, but potentially serve in a succession capacity to the Investment Team at large. Staff recommends that the Incentive Compensation Plan be adjusted to include the Associate Investment Officer with a target 10% rate.
Staff will provide the Executive Committee with proposed changes to the Incentive Compensation Plan and rubric, for discussion and consideration.
As with prior resolutions on the Incentive Compensation Plan, any Investment Officer must be an employee of SBCERA at the time the award is paid, and in no case shall SBCERA be liable for any partial payment should the Investment Officer not complete the full fiscal year of employment.
BUDGET IMPACT:
Costs for this item are included in the current year non-administrative, investment budget.
STRATEGIC PLANNING GOAL/OBJECTIVE:
Quality Employer and Workplace
STAFF CONTACT:
Debby Cherney
Stacey Barnier
ATTACHMENTS:
Exhibit A: Incentive Compensation Plan adopted 2022