The Studies Pile Up and Trust Diminishes: Further Thoughts on South Carolina
Last week I wrote about the censure of the South Carolina State Treasurer by the Retirement System Investment Commission. Undoubtedly, the losers in this battle are the beneficiaries of the pension plan and the taxpayers. In the last few days, I’ve been thinking about the winners in this unfortunate saga. Clearly, this has been great sport for the media. For example, the South Carolina pension plan will forever be linked to the yellow Lamborghini driven by the former Chief Investment Officer, and the Commission’s censure of the State Treasurer will be known as a badge of honor.
Investment consultants are the biggest winners. The Commission issued a press release trumpeting that an “Independent National Consultant Validates RSIC Fee Levels and Applauds Uncommon Level of Transparency.” Ironically, the report by Hewitt Ennis Knupp (HEK) extolling the Commission’s transparency hasn’t been released. The State Treasurer has also commissioned a couple of reports by Deloitte and Touche (D&T) on appropriate standards for policies and procedures. At least those reports are publicly available on his website.
The paper mills also stand to do well. The reports by HEK and D&T are, undoubtedly, leading to the production of lengthy policy manuals, investment procedures, and checklists. Of course, this may be a hidden benefit to the State of South Carolina if all of this material is printed on paper produced in state. However, multi-volume procedure manuals do not create good or even adequate performance. All they do is create even more paper in the form of reports and documents that will fill file drawers and hard drives. When policies and procedures dominate the investment process, critical assessments about the efficacy of money managers are buried by a “check the box” mentality.
I am certainly not advocating an investment process void of procedure. When I arrived in North Carolina, there were no written procedures, and in due course, we came up with about thirty pages defining how we conducted the various activities of investing, such as asset allocation, hiring and firing managers, and assessing performance and risk. In my view, our manual was still too brief. However, if a pension plan stores its procedures in one or more four-inch binders, then process is likely to overwhelm substance.
Here’s the problem. Consultants are retained and procedure manuals blossom into encyclopedias when trust breaks down. Successful investing is the by-product of two intangible ingredients: trust and judgment. You must have a level of trust between money managers and staff, between staff and the trustees (commission members in SC), and among the trustees. Without trust, suspicion rules the day. I speak from experience. When Treasurer Moore succeeded Treasurer Boyles in North Carolina, we treaded warily on the decisions made the previous Treasurer. And, when Treasurer Cowell replaced Treasurer Moore, doubt led to consultants and lots of new procedures. South Carolina is in the throes of this debilitating exercise.
Without trust, there is no way to accept the critical judgments that form the basis for asset allocation and manager selection. More disturbingly, an investment organization void of trust and judgment will be unable to tolerate mistakes, and there is no such thing as error free investing. Investment decisions go from mediocre to terrible in an environment where every mistake is ripe for second-guessing and political spin.
Late last September, I wrote a piece called “Back to Values” that described the laudable goals, policies, and procedures developed by our largest banks prior to the credit crisis. These organizations knew how to “check the boxes” and create paper compliance. It is one of the reasons it is so hard to sue these organizations and their executives. The real problem at the big banks is that they lacked sound values like trust and judgment.
If I were a taxpayer, civil servant, or public retiree in South Carolina, I would be hoping that the Commission could restore trust, rein in the consultants, and eliminate about two-thirds of the policies and procedures. If that happened, they’d have a shot at some decent investment results.