The Speculation State: North Carolina Gambles With Its Budget and Pension
What a great time to be a wealthy person in North Carolina. Governor Pat McCrory and the General Assembly have given you a tax cut you didn’t need, while creating an investment environment in North Carolina that will encourage you to invest any place other than your home state. The budget enacted by the legislature will create an economic and social climate in North Carolina that is antithetical to sound long-term investment. Why would anyone make a long-term investment in North Carolina when the legislature isn’t willing to invest in our schools and colleges? Why should they consider sinking money into North Carolina when our state and local governments will lack the funds to provide basic services? North Carolina developed a reputation as a progressive state under the leadership of Democrats and Republicans over a forty-year period. In one session of our legislature much of the good work has been undone. 
The damage done by our elected officials is so great that it will even penetrate the walls of gated communities in the hills above Asheville, on the outskirts of Chapel Hill, and behind the dunes on the outer banks. Thus, the good times will not last for even the wealthy in North Carolina. Our legislature and governor have created an economic and social climate that will eat at any one with a conscience.
However, it’s always a great time to be big-time money managers. The General Assembly and our State Treasurer have news that will get them to interrupt their vacations on the Hamptons, clamber onto their G650s, and fly on down to Raleigh. Senate Bill 558 passed both houses of the General Assembly, and when the Governor signs the bill, private equity and hedge fund managers will have even more opportunities to pad their pocketbooks. The legislation allows the state’s public pension plans to increase their investments in alternatives. It’s hard to say exactly how much this legislation is worth to money managers, because the State Treasurer doesn’t disclose how much of the pension is invested in hedge funds. A chunk of these investments are buried in a broad category called Global Equity. I’m guessing that money managers will make an additional $75 to $100 million in management fees annually when the increased allocations to alternatives are completed. Wall Street traders and investment bankers will probably earn a similar amount in commissions, fees, and expenses from the underlying investment funds. And by the way, this isn’t a one-time deal. They’ll earn this kind of money year in and year out.
The goal of this further foray into alternatives is to earn a higher return for the pension plan in order to prevent the plan from running a larger long-term deficit. By now you probably know that I am skeptical of this approach, because I don’t think large institutions can earn decent long-term returns from most alternative strategies. It is simply too much money chasing too few profitable ideas.
The push into alternatives also has a bad side effect that is entirely consistent with the policies espoused by our state legislature. Many of the alternatives entering the pension plan, aren’t investments at all; they are short-term speculations. While the pension plan has long-term obligations to its beneficiaries, more and more of its assets are being plowed into options, futures, swaps, and other short-term trading strategies. While there’s some small risk that these speculative endeavors could unwind, I am more concerned about the profound mismatch between short-term bets and long-term liabilities.
Apparently, long-term investing in North Carolina, whether it’s in our schools, roads, or pension plans is a thing of the past. We have become the speculation state. Our legislature having departed the scene, the tally is clear. Hundreds of millions of dollars were available for the wealthy and money managers, but no money was available for the poor, our teachers, or state employees. For those of us with money to invest, the message is rather obvious. Look elsewhere.
 See, http://www.newsobserver.com/2013/07/27/3062658/from-the-start-a-breathtaking.html for an excellent summary of the General Assembly’s damaging handiwork.
 A small group of managers will earn large bonuses or carry. This bounty will amount to another $100 to $200 million, but you’ll never know about it, because pension plans don’t reveal this information. At least, those investments will have earned something of a decent return.
 The pension plan must earn more than 7.25% over the long run, or the accounting rules require the legislature to increase the state’s financial support for the pension. If the return assumption were reduced to a more realistic level of 6.75% or 7%, it would also trigger increased contributions. Since our General Assembly is fiscally irresponsible to begin with, it’s doubtful that they’d increase the appropriation for the pension. Thus the Treasurer has to hope hedge funds, private equity, commodities, and real estate can fill the gap.
 Alternative investments should be classified into two categories: investments, which include private equity, real estate, and perhaps certain credit strategies; and, speculations, which encompass many hedge funds and commodity strategies. The problem with the investment category is that too much institutional capital is chasing the same strategies, so it will be very challenging to generate the expected returns. In other words, almost everyone is making the same bet on what would otherwise be legitimate investments. The speculative category is also attracting too much money, but it is also no place in a pension plan. Of course, both categories are infused with ridiculously high fees.