Monday, August 5, 2013

The Exception to the Rule about Alternatives: MOSERS

The Exception to the Rule about Alternatives: MOSERS

When it comes to investments, the Missouri State Employees Retirement System (MOSERS) is one of the best-managed pension plans in the country.    The plan relies fairly heavily on alternative investments and especially hedge funds.  Over the past decade the plan has generated a 10.1% return.    I’ve been rather outspoken about the problems of adding alternatives to public pension plans, so my endorsement of MOSERS may seem more than a tad inconsistent.   MOSERS is the exception to the rule. 
 
Weighing Taxes (1995)
The trustees and staff at MOSERS didn’t pile into alternative investments overnight.  Rather, they deliberately and slowly put together a program well before most other public pensions had even thought about alternatives.  Moreover, they were able to operate at a relatively small scale because their total assets are only $7.7 billion.  MOSERS has one additional advantage over other public pension plans; it has had the same Chief Investment Officer, Rick Dahl, for well over a decade.  When I started my job as CIO for North Carolina, one of my first calls was to Mr. Dahl.

As you’d expect, MOSERS is almost always exhibit A when public pension plans attempt to justify their foray into alternative investments.  Endowments and foundations have their own prime example, the Yale University Investment Office.  The argument goes as follows.  MOSERS (or Yale) have earned extraordinary returns by investing in alternatives.  We can do the same thing, even if we have to pay higher expenses.

 The lessons are pretty obvious.  While there are some risks, reputational and otherwise, from being a pioneer, there are advantages to moving into a new investment area before it becomes mainstream.  In addition, successful programs are never built quickly.  Developing internal expertise and finding managers worthy of their high fees takes a great deal of patience.  Being a first-mover and acting deliberately aren’t sufficient.  If you are going to invest in alternatives and pay high fees, you’d better have very skilled investment officers and hold on to them.

The State, Columbia, South Carolina’s newspaper details the debate over the high fees paid by the South Carolina Retirement System, and the relatively low returns generated by the plan in the last five years.[1]  As expected, the State’s Investment Commission defends its foray into alternatives and the resulting fees.  The Commission also attacks a study out of Maryland that reports that South Carolina has the highest fees in the country.  I wrote about the study in “Fees and Investment Performance: Confusing Correlation and Causation (July 5, 2013).”  While that study has a few flaws, its conclusion about South Carolina is on target.

 I fully expect the South Carolina Investment Commission to defend its program, attack studies concerning its fees and performance, and try to draw comparisons to Missouri.  In my view, South Carolina’s and Missouri’s investment programs don’t share much in common other than their above average exposure to alternative investments.  South Carolina came to the alternative investment class late, rather than early.  They constructed their program quickly, rather than deliberately.  And, the chief architect of South Carolina’s program, Robert Borden, didn’t last in Columbia.  The odds of South Carolina replicating Missouri’s experience are remote. 

Treasurer Curtis Loftis, a steadfast critic of the investment program in South Carolina, asked the State’s Inspector General to review the program.  A couple of weeks ago, the IG, Patrick Maley issued his report.[2]  The IG didn’t find any illegal conduct.  He did, however, suggest a series of improvements in procedures and communications.  The IG also urged the State Treasurer and the other members of the Investment Commission to find a way to lower their mutual levels of mistrust. 

In my view Mr. Maley got it right.  South Carolina made a series of investment blunders.  However, investment errors weren’t illegal.  Unfortunately, they are all too common, and when they occur the folks who made the missteps almost always refuse to concede that they erred.  Rather, they look to justify their position.  When it comes to alternatives, almost every public pension plan cites MOSERS to defend its actions.  Sorry to say, Missouri is the exception to the rule that alternatives can benefit public pensions.




[1] http://www.thestate.com/2013/08/04/2899341/officials-debate-merits-of-study.html
[2] http://oig.sc.gov/Documents/Review%20of%20Red%20Flag%20Indicators%20of%20Potential%20Wrongdoing%20At%20the%20Retirement%20System%20Investment%20Commission.pdf

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