Tuesday, June 4, 2013

Investing In-State: Acceding to the Pressure

Investing In-State: Acceding to the Pressure

Every public pension plan faces pervasive pressure to invest in their local economies.  From the moment that I stepped into the role of Chief Investment Officer for the North Carolina Retirement System, supplicants began phoning me seeking an investment in North Carolina by the pension plan.  Perhaps my biggest mistake was having voicemail installed in the investment office because many of those inquiries would have otherwise gone unanswered.  The solicitation was always the same: the pension plan can do well at the same time as the local or regional economy is benefitted.  This line of argument might hold water if the predominant advocates weren’t self-interested money managers, and the plea wasn’t laced with heavy concentrations of political pressure.  Whether you poke around a pension plan on the east or west coast or somewhere in the middle, you’ll find this argument being successfully applied.

Internet Hype (2001)

The trustees at public pension plans go to extraordinary lengths to paper over the politics that accompany the requests to invest locally.  Some plans will set up small, dedicated funds aimed at local or regional investments.  The idea is simply to limit the damage.  Other states, such as North Carolina, will hire an outside manager to act as a conduit for these types of investments.  In yesterday’s post, I referred to this initiative, the Innovation Fund (“Hunting for Capital in North Carolina [June 2, 2013].”  This is a very expensive way of investing, as the fund incurs a separate set of fees in addition to the costs associated with the underlying investments.  However, this model buys a degree of political insulation as an outside party, who is ostensibly objective, makes the investment decision.

I’ve worked with several treasurers in North Carolina and they all succumbed to the pressure.  Treasurer Harlen Boyles, who held office from 1977 to 2001 employed the State’s banks to manage large portions of the pension plan’s equity assets.  In 1989 he also sought authorization to invest in an entity called the North Carolina Enterprise Corporation as well as a limited amount of venture capital.[1]  The bill’s title made no mention of the pension plan and mainly involved utility taxes.  The provision was slipped into the middle of the legislation.

Under Treasurer Moore, I faced a lot of pressure from local managers, especially after the General Assembly approved the 5% alternative allocation.[2]  While the provision did not explicitly mandate instate investments, the local private equity and hedge fund community lined up at my door to get a chance at managing some money.  We turned down the vast majority of these inquiries, but a few managers received mandates.  One manager had the misplaced confidence to bring contracts ready for the Treasurer’s signature to our first meeting.

In 2005, Treasurer Moore received authority to invest 20% of the Escheat Fund in equity and alternative investments.  While I wasn’t there to administer this new investment authority, I had a hand in drafting the bill.  The idea was to provide a home for smaller state investments without gumming up the pension plan.  Treasurer Moore wasn’t the first one to use the Escheat Fund to invest in the state.  The General Assembly authorized the Treasurer to invest $25 million in the Global Transpark, located north of Kinston, (originally named the Air Cargo Airport) out of the Escheat Fund in 1991.[3]  As far as I know, the investment is still outstanding after all these years.[4]

Whether it's North Carolina’s Innovation Fund, CALPERS’s California Initiative, or Indiana’s In-State Private Equity Fund, these programs all do more to relieve political pressure than to help achieve the long-term financial objective of their respective pension plans.  The trustees, of course, can never admit that politics is playing a role in the decision to create one of these programs.  Rather, these initiatives are set up so that they have the appropriate appearance.  

There’s virtually no way to insulate public pension plans from these kinds of pressures.  We can only hope that these in-state efforts remain small enough that they don’t inflict any significant damage on public pension plans.

[1] See, section 11 of Chapter 813 of the General Assembly of North Carolina, 1987.
[2] See, section 2 of Chapter 444 of the General Assembly of North Carolina, 2001.
[3] See, section 8 of Chapter 749 of the General Assembly of North Carolina, 1991.
[4] Interestingly, the law is meant to hold the Escheat Fund harmless if the loan to the Global Transpark goes bad (NCGS 147-69.2(11), but after two decades I don’t think the fund had been repaid.

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