STUMP » Articles » Kentucky Update: Republicans Take Legislature, Pensions Still Suck, Hedge Funds to Exit » 18 November 2016, 10:04

There were things other than ballot initiatives and president being voted on last week. Today, let’s look at Kentucky:

Republicans take the Kentucky House after 95 years of Democratic control

Republicans achieved the trifecta in Kentucky politics Tuesday, wresting control of the state House from Democrats in a landslide to complement their rule over the governor’s office and state Senate.

“The people of Kentucky have been heard and they want a new direction for the commonwealth of Kentucky,” said an ebullient Gov. Matt Bevin, who is expected to benefit mightily with a GOP-led House committed to his conservative agenda.

Republicans last led the chamber in 1921. Going into Election Day, the Kentucky House was the only law-making chamber in the South still controlled by Democrats, who held a 53-47 majority.

Longtime House Speaker Greg Stumbo, D-Prestonsburg, was among 17 Democratic incumbents swamped in the Republican wave. Stumbo has been in the House since 1980, except for four years to be state attorney general from 2004-2007. He has been speaker, the top leadership job in the House, since 2009.

Let’s take a quick look at Kentucky political history.

GRAPHS OF KENTUCKY POLITICAL POWER

Using this Wiki Page on political party strength, I’ll show how parties split out by 2-year intervals (how often elections occur — Kentucky Senate has 4-year terms, House has 2-year terms).

First, the one major change: Republicans taking control of the state House.

Something to note: the Republicans have taken control of the state House before, for a 2-year period. And promptly lost it. So there’s nothing necessarily permanent about this situation.

The longer-term trend: Republicans increasingly taking control of the state Senate.

The Senate composition moves slower, probably because the Senators have 4-year terms, with only half the Senate up for election every two years.

Spreadsheet behind the graphs can be downloaded here.

At the state level, the only Democrats in 2017 will be Secretary of State Alison Grimes and State Attorney General Andy Beshear. Grimes ran against Senate Majority Leader Mitch McConnell for the Kentucky Senate seat, and lost. Beshear is the son of a prior Kentucky governor, actually, the governor preceding the current governor: Republican Matt Bevin.

One bit of commentary:

Opinion: Kentucky as a GOP state

FRANKFORT, Ky. – The election was a political earthquake for the nation, but especially in Kentucky, where Republicans were transformed into a truly ruling party for the first time in almost a century.

…..
There is also potential for conflict between Republican legislators and Bevin, who will want them to reverse a court ruling that he lacks the power to reorganize university boards, and may ask them to require teachers and state workers to work longer than 27 years to get full retirement benefits.

Bevin told Bill Bryant of Lexington’s WKYT-TV that he doesn’t understand why teachers are allowed to retire when they are only 49 years old and at the height of their talents.

Well, the governor surely understands why we have 27-year retirement: legislators have long been responsive to the needs and wants of state workers and teachers, and the Kentucky Education Association has been one of the most powerful lobbying groups in Frankfort. And state universities are pretty good at lobbying, too, so there could be a battle over giving the governor more power over them.

Tax reform, which will likely wait for a special session or the 2018 session, has all kinds of potential for conflict because so many interests will be involved. That also offers the possibility of conflict among ideological Republicans and more moderate types who don’t consider themselves anti-government.

One big question is whether Bevin wants any reform package to be revenue-neutral. Most governors want some money to spend, and stabilization of revenue is essential for the pension reform that is Bevin’s top priority, and for the long-term financial health of the state, which has seen its tax base erode for decades as the tax code has not stayed current with the economy.

They could retire at 49?!

I guess this graph is no surprise:

More on the effect of the change in party control:

Looking forward to change with Republicans holding reins in state

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Thirdly, Kentuckians grew tired of seeing now-former House Speaker Greg Stumbo act as chief obstructionist of the House chambers. Each year, legislation that could actually move this state forward and attract businesses and companies here were blocked by Stumbo, who continuously provided political cover to his union buddies. He was also holding the children of this state back by trying to appease the teachers’ union in Jefferson County by not allowing charter schools to be voted on in the House. Gov. Matt Bevin summed up Stumbo best when he referred to him as a “thorn in the side of any number of good people for many years for purely political reasons.”

Stumbo will also not be missed because he was often on the wrong side of government transparency issues.

Stumbo was instrumental in blocking efforts to make Kentucky’s struggling pension funds more transparent and had launched a lawsuit to overturn vetoes by Bevin of legislation that would eliminate the requirement of newspaper publication of local government and school district financial statements.

I can guess the arguments made there.

KENTUCKY PENSIONS: NOT AS BAD AS NEW JERSEY

So let us look at prior Kentucky posts from just this year:

• Kentucky Pensions Update: Governance Woes
• Kentucky update (and trying something new)
• Kentucky Pensions Update: Their Investment Returns Also Sucked
• The Woefully-Underfunded Kentucky Retirement Systems
• Kentucky Update: They’ve Got Budget Blues, Too

It’s pretty much driven by pension issues, and you can look at those prior posts to check out what’s been going on. Pension reform was one of the big issues Bevin came in on, and there’s been a lot of wrangling over control of the Kentucky Retirement System funds.

Also, Kentucky was rated one of the worst-funded pension systems at the beginning of November:

New Jersey became the state with the worst-funded public pension system in the U.S. in 2015, followed closely by Kentucky and Illinois.

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Broad numbers mask big difference in the health of public pensions between states. While New Jersey only has 37.5 cents available to pay each $1 of benefits, South Dakota, the state with the best-funded pension, had $1.04, according to data compiled by Bloomberg. Kentucky, the state with the second-worst funded retirement system, had a ratio of assets to liabilities of 37.8 percent, followed by Illinois at 40.2 percent.

Yay. Kentucky is not as bad as New Jersey. As I commented at Wirepoints, don’t be grabbing at New York’s motto.

SUING OVER INVESTMENT PERFORMANCE

I’ve not been updating the Kentucky situation as often as I should be.

For example, this story from September — Court rules Kentucky pension systems can be sued for bad investments:

Kentucky Retirement Systems cannot cite sovereign immunity to avoid a lawsuit alleging it has squandered hundreds of millions of dollars on “illegal and imprudent investments,” the state Court of Appeals ruled Friday.

The suit, filed as a class action in 2014 by the Northern Kentucky city of Fort Wright, alleges that KRS violates the law with risky investments in hedge funds, venture capital funds, private equity funds, leveraged buyout funds and other “alternative investments” that have produced small returns and excessive management fees.

KRS is the public agency responsible for providing retirement benefits to more than 355,000 past and present employees of local and state governments. In its defense against the suit, KRS said it could not be sued because of sovereign immunity — a legal concept that generally protects governments from legal liability.

A Franklin Circuit Court judge rejected KRS’ defense, a decision the Court of Appeals upheld on Friday. Among the flaws in KRS’ argument, the appeals court said, the law establishing the KRS board of trustees explicitly says the board can sue and be sued in return.
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The Herald-Leader reported last month that KRS is doubling down on a hedge fund that is one of its worst performers: Prisma Capital Partners’ Daniel Boone Fund, which represents 5 percent of the systems’ assets and produced a negative 8 percent return in fiscal 2015. KRS officials defended the investment, saying that hedge funds give the systems’ portfolio diversity over the long run.

Yeah, well, they reversed themselves on that at the beginning of November, and they’re not alone:

Kentucky Plans to Pull At Least $800 Million From Hedge Funds
State’s retirement system has a total of $1.5 billion in hedge funds, representing 10% of its total assets

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The Bluegrass State is in line to become the latest investor to back away from hedge funds due to uneven results and concerns about high fees. Pension funds in California, Rhode Island, New Jersey and New York all have pulled money from the $2.9 trillion industry, which has underperformed broader financial markets since 2009.

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But now Kentucky’s public employee plan, one of KRS’s five pension plans, has only $2.3 billion of the $12.4 billion it owes state workers, according to financial statements for the year ended June 30, 2015. The funding level has left board members anxious to keep investments fairly liquid and avoid high fees, Mr. Eager said.

“We’re in a new normal low-return environment,” Mr. Eager said. “Two percent off the top is a big hit.”

……
The investment committee that is pursuing a hedge-fund retreat is made up of officials new to the KRS board. All five voting members of the investment committee were appointed by Gov. Matt Bevin, who made shoring up the fund a key platform of his gubernatorial campaign last year.

The Republican’s office has contracted with an outside consultant to audit the pension fund and expects the review to be complete by year-end, according to a spokeswoman.

As noted, Kentucky isn’t the only pension fund doing this.

KENTUCKY GIVES HEDGE FUNDS THE BOOT

Kentucky identifies 12 hedge funds to cull as part of plan to halve the portfolio size:

The investment committee of the $15 billion Kentucky Retirement Systems, Frankfort, recommends eliminating 12 direct hedge fund investments and reducing its allocation to hedge fund-of-funds manager KKR Prisma by roughly $300 million by July 2019, said David Peden, chief investment officer.

David L. Eager, interim executive director, told Pensions & Investments earlier this month that the investment committee approved redeeming $800 million of its total $1.5 billion hedge fund investments by July 2019 to simplify investments, improve liquidity and transparency and cut fees.

……
Fifteen underlying hedge funds in KKR Prisma’s roughly $700 million fund-of-funds portfolio are also recommended for elimination by July 2019, said Mr. Peden. Those investments amount to about $300 million.

Direct and underlying hedge fund strategies that are not eliminated by July 2019 are expected get a more thorough look to see whether they are “high added-value” strategies and good diversifiers and should be retained, ideally in an alternative format like a separate account, Mr. Eager also previously said. Those targeted for further review include global macro, trend following and relative-value strategies.

If underlying managers in KKR Prisma’s portfolio are retained, those could be turned into direct relationships and KKR Prisma would be retained for a niche/tactical trading strategy, said Mr. Peden.

The investment committee’s hedge fund decisions must still be ratified by the full board. The next board meeting is Dec. 1.

The specific funds don’t really matter. The point is that Kentucky pensions are so underfunded that one of their Hail Mary passes has been to try to reach for investment returns… which haven’t materialized.

Pension plan “in far worse shape than people realize,” Sen. McDaniel says:

FRANKFORT — Even after substantial reforms to the state pension systems Republicans and Democrats in the state Capitol have serious concerns about the state of the retirement system.

Senate Budget Chairman Chris McDaniel, R-Taylor Mill, says the “biggest thing” lawmakers need to do is “be honest with ourselves” about the state of the Kentucky Retirement Systems.

“The fact of the matter is some of the underlying assumptions inside of this pension system are just not holding true,” McDaniel said, pointing to assumptions on returns and payroll growth.

The Taylor Mill lawmaker said the KERS non-hazardous pension plan “is in far worse shape than people realize.”

…..
McDaniel lauded Gov. Matt Bevin’s moves to “clean up the mess” by reforming the pension board of trustees. The Northern Kentucky lawmaker also predicted that this type of lawsuit is “likely not last thing like that the state will see.”

The two-year state spending plan earmarks more money for the pension systems, but McDaniel said the state will not be able to pay off $31.2 billion in unfunded pension liabilities over the next 30-years.

“The problem is even over the next three decades we’re not going to be able to fully erase this unfunded liability, and frankly that’s too long to continue to wait on this solution,” he said.

McDaniel is hopeful an outside audit of the pension systems will set a path to correct poor investment performance and other short comings. The Taylor Mill Republican is also calling for transparency reforms to legislative pensions and is expressing a willingness to move the funded legislative pension system into the KERS non-hazardous plan.

“Should we close that plan and move all legislators over to KERS non-hazardous? I absolutely think we should,” he said, questioning if other lawmakers would be willing to move in that direction during the legislative session.

That would be interesting.

I will be trying to keep a more frequent watch on Kentucky for now, as it seems there should be action with respect to pensions, at least in the new year.

Many other states, such as Illinois or New Jersey, seem caught in a state legislative deadlock, but that won’t be the case for Kentucky to an extent, I think.

For those who thought 2016 was a rollercoaster thrill ride… just watch out for 2017.

Compilation of Kentucky posts