Top officials from Chicago's futures industry gathered a week ago in the marbled lobby of the historic Rookery Building on LaSalle Street. They were there for one reason - to get Illinois Treasurer Patrick Quinn to blaze a path for managed futures in the state's multibillion-dollar pension funds.
"If the Illinois funds as a group came into managed futures, it would send a signal to the rest of the country that it's not a bad thing. It makes sense," said Robert Kelley Jr., a vice president at M.C. Baldwin Financial Co., the Chicago-based commodity pool operator that sponsored the Rookery reception.
Quinn does not disagree. After all, Illinois, or more precisely, Chicago, is the birthplace of the futures industry and the home of the two largest futures exchanges in the world: the Chicago Board of Trade and the Chicago Mercantile Exchange.
Futures, particularly the managed kind that hunt for profits in markets, have been around for a long time. However, pension funds are relative newcomers to the concept, and getting them on board hasn't been easy.
Pension fund managers tend to stick with conservative investments such as stocks, bonds, and real estate. While they might use futures as a hedge, few public pension funds have ventured into futures as an actual investment class.
The pension funds mean big business to the exchanges and to managed futures firms. And an even healthier futures industry can only be good for the state of Illinois.
"We need to make Illinois an entrepreneurial state. We've got to invest in our state, in things like managed futures, where we have expertise," Quinn told the Rookery gathering.
If a Chicago futures firm were to call on a pension fund from North Dakota, for example, a likely question would be whether Illinois funds use futures, Quinn said.
"And if Illinois isn't, they'll tell you not to talk to them," the treasurer said. "Illinois can help open up the market for the pension community in the U.S."
Quinn Plays Host
Last week's meeting was not the treasurer's first with futures officials. In May, Quinn hosted a meeting of Midwest state treasurers in Chicago that included tours of the two futures exchanges and even a mock trading session.
At the Rookery, Quinn pointed out that futures could be beneficial for pension funds, like the ones in Illinois, that have seen state contributions shrink because of fiscal problems.
"Our state is in serious financial difficulty. For 14 years we've underperformed the national economy," Quinn said. "The state doesn't contribute what it should to pensions, and that puts more pressure on trustees to come up with a good performance. Managed futures can have a role in helping trustees meet their fiduciary duty."
The Illinois treasurer made it clear he will work with the futures industry to get the 13 major pension funds in the state familiar with futures.
Quinn, a trustee for the Illinois State Board of Investments, which has about $5 billion of assets for state employees, judges, and lawmakers, said he has introduced resolutions calling for the use of managed futures by the fund. None of them have been adopted.
"With any new product you get a lot of skepticism," he said.
Some state pension funds in the country do currently use futures as a tool to hedge their investments in underlying securities. For example, they may use the U.S. Treasury bond contract at the Chicago Board of Trade to hedge their interest rate exposure, or the Standard & Poor's 500 Stock Index futures contract at the Chicago Mercantile Exchange to hedge the value of their stock portfolio. They may also use futures as an asset allocation tool, to make quick changes in exposure among the markets.
Managed futures, however, is a separate asset class, just like stocks, bonds and real estate, according to Patrick Catania, vice president of market development at the Chicago Board of Trade. Managed futures entails the hiring of professional advisers to construct a program to earn returns from the use of futures as an investment, just like an investment in stocks or bonds.
"The real crux of our effort is to get [the funds] beyond the use of futures as a risk management tool in their existing portfolio and to get [the funds] to place X amount of dollars in managed futures as an investment class," Catania said.
Robert G. Easton, chairman of the Managed Futures Association and president and chief executive officer of Commodities Corp., acknowledged that state pension funds have not been widespread users of managed futures. But he pointed out that the association is working to educate the funds.
"We believe managed futures have an appropriate place in a portfolio of investments." Easton said. "They have a historically attractive return, and a 5% to 10% allocation is a good portfolio strategy.
Virginia Goes First
What the rate of return may be remains a point of discussion in the industry. Catania of the CBOT said that while managed funds have done well over all, an effort is underway to establish a benchmark return that can be used to market managed futures to pension funds.
So far, the Virginia Retirement System is the only concrete example that futures and pension fund officials can cite of a state fund that uses managed futures in a big way. The state fund made headlines in 1991 when it allocated $100 million for a managed futures program. But the use of futures in Virginia has proven to be controversial.
Earlier this year, state Sen. Robert E. Russell Sr. introduced a bill that would prohibit the Virginia fund from trading futures. He claimed it was "out of character" for Virginia to be on the cutting edge of investing. Russell's fellow lawmakers did not agree or disagree with his assessment. The legislature decided to conduct a complete review of the system's investments, and the Joint Legislative Audit and Review Commission is scheduled to submit the study in November.
John McLaren, the Virginia Retirement System's managing director of alternative investments and derivative strategies, said he has spent "hours" with the people conducting the study, and said he believes Russell "will not be pleased with the report."
"The problem is [Russell] does not understand modern investment techniques nor does he choose to understand modern investment techniques," McLaren said.
He added that futures have been part of the fund's strategy since the mid-1980s.
"We use futures in general in most of our program. Futures are an integral part of our investment strategy," McLaren said. "And managed futures have met our expectations to date."
The Virginia fund uses managed futures to replicate cash returns "in a cheaper fashion," McLaren said. He pointed out that the $15 billion fund now comprises $180 million of managed futures.
Still, other state funds have not followed Virginia's lead. One reason could be the inherent risk in embracing an investment strategy that has not been universally embraced by the pension fund community.
"You have to understand people in my position. We don't get compensated based on performance," McLaren explained. "If you go out on a limb and do managed futures and [the program] does well, they don't pay you more. If [the program] blows up, you'll probably get fired."
DeWitt Bowman, chief investment officer of the California Public Employees' Retirement System, said he does not believe there is a separate place for managed futures in his fund. The $76.5 billion fund has used futures "operationally, not as a primary investment tool" for three or four years, he said.
But Bowman said there are too many variables inherent in a managed futures Program, including hidden costs and changeable market factors, Whereas owning securities such as stocks and bonds allows for a certain amount of control.
In the meantime, the eyes of the futures industry are focused on the Illinois treasurer and the marketing boost he may give to managed futures. But if the Illinois funds are swayed by Quinn, will that make a difference to the California retirement system, the nation's largest state fund?
The system "has not been a follower," Bowman said. "The question of putting in another investment category has to be understood and managed, and if it doesn't provide us with a dramatically different exposure and return. it can be an operational disincentive."