Karen Mazurkewich
National Post
February 20, 2009

Pension funds are the walking wounded, but in the coming months expect them to start carrying a heavier stick.

Institutions have taken huge hits in the public equities markets and alternative asset classes. Now, many are giving the market a little push back.

In addition to seeking management fee concessions and lower execution costs for trades, they are leading a new crusade for reforms.

"You don't want to lose the opportunity that a good crisis brings you," says Jim Leech, president and chief executive of Ontario Teachers' Pension Plan (OTPP).

While Mr. Leech says the pension fund will be reporting losses for only the third time in its history come April, the fund still has an enormous asset base. "We can use it to provide stability in the marketplace," he says.

Pension funds have an important role to play in improving corporate governance, says John Van Reenen, director of the Centre for Economic Performance at The London School of Economics and Political Science.

Last week, his group issued a report that documented the rise of institutional ownership in companies from the 1950s to today. Although hedge funds have played a role in the market meltdown, the study concludes that on the whole, the rise of institutional involvement in the markets has been a positive force for innovation and growth. That's because institutions spend a lot of time investigating what the senior executives are doing, says Mr. Van Reenen.

"The better pension funds are much more activist and I think you will see that trend increase in this economy," he says.

Even though the pensions have seen their assets slide, they still have a massive cash arsenal. Now more than ever, they need to flex their muscles to see what the chief executives are up to, adds Mr. Van Reenen.

Pent-up frustration has motivated The California Public Employees' Retirement System, the largest pension fund in the United States, to rally a group of other big pension funds to address market reform.

This week it OK'd a draft version that calls for greater transparency (on and off balance sheets), the restructuring of the regulatory agencies, more standardization of global accounting standards, access to the proxy for share-owners who want to list their own board nominee on corporate election ballots and, finally, stronger limits and checks on executive compensation packages.

We've been through a cycle where the influence of investors was low," says David Denison, president and chief executive of Canada Pension Plan Investment Board.

"There was a wall of money wanting to be invested by general partners, so we are taking the opportunity to get better terms for us, and that's playing out in a variety of ways," he adds. "We are using our negotiating power to get better fees particularly around performance and how the manager is going to be compensated," he says.

OTPP is seeing "tons of opportunities" to squeeze more value from the system, ranging from execution costs for trading to management fees. "To be paying this crazy '2 and 20' on a high water mark basis, it does not, and never did make sense," he say, referring to the performance fee calculation that is based on increases in the net asset value on hedge funds.

But at the top of Mr. Leech's list is corporate governance issues. Last month, Ontario Teachers' Pension Plan sent a "pre-emptive" letter to the companies they have investments in warning them not to use the global stock market sell-off as an excuse to reprice options it uses to pay executives. "Markets went down and some companies might be motivated to (reprice), but we say that's dilutive, and can be oppressive on the owners ... think about that," Mr. Leech says.

"We think compensation is an area that needs to be a hard look; pay for performance has got to mean something."

He'd like to see executive compensation tied to a four-year performance. "Some of the pay structures that are in existence are counter productive ... when management destroys value and gets rewarded for it, it's an area we look at carefully."

Mr. Leech says OTPP devotes a lot of time on meetings with boards of companies.

"Financial institutions, can't be too happy with some of their risk measurement processes, those are discussions we've had with banks, as well as compensation practices," he says.

For the most part, the boards are welcoming our input, he adds. "They find themselves, sometimes held hostage by the chief executive and senior management team with threat of walking out or just pouting and sitting in the corner with a big lip if they don't get [what they want]."

Whether the pension funds have much impact in reforms is yet to be seen. But there is consensus among the pension managers that change must happen.

"As long as the tide was riding high, people didn't feel altogether bad about payments to executives, but what we are telling ourselves now is that wasn't all [just about] skill, it was about markets rising where interest rates were low," says Leo de Bever, chief executive of Alberta Investment Management Corporation.

He says pensions will be looking carefully at how companies structure corporate packages. We have "moral ammunition" on our side now, he adds.

Material reprinted with the express permission of The National Post Company, a Canwest Partnership.