Wednesday, December 11, 2013

A Misguided Analysis of Pension Returns

A Misguided Analysis of Pension Returns

The State Employees Association of North Carolina (SEANC) issued a highly misleading press release[1] last week calling the performance of the NC pension plan “dismal.[2]  I’ve looked at the same set of numbers that prompted SEANC’s diatribe, and I see a perfectly acceptable set of financial returns.  In fact, both the short-term and long-term results are entirely consistent with the conservative investment philosophy espoused by Treasurers Boyles, Moore, and Cowell over the past three decades.

Illiquids (1999)
SEANC claims that Treasurer Cowell’s strategies haven’t worked because the pension plan has underperformed relative to the average pension plan for the third quarter of this year.  I’m surprised that a state organization with over seventy-three years of experience s would make such an elementary mistake.  Anyone who has followed the pension plan knows that North Carolina’s investment returns have lagged those of other pension plans in rising markets and exceeded the returns of other retirement plans in bad investment markets.   Treasurers Boyles, Moore and Cowell have been unwilling to take as much risk as the average plan, and thus North Carolina’s equity exposure has been lower than average.  The retirees, state employees, and taxpayers have been well-served by this approach, which is demonstrated by North Carolina’s laudable ranking as one of the best funded pension plans in the United States.[3]  

 NC Pension Returns as of September 30, 2013



SEANC ignores two pieces of good news in the most recent set of returns.  The pension plan has earned more than its expected return of 7.25% for the past five years and has exceeded its benchmark for all measurement periods.  As the returns for 10 and 15 years show, North Carolina, like all pension plans, is dependent on equities to drive returns.  Over the 10 and 15-year periods, the average of global stocks has only returned 7.0% and 5.2%[4] respectively, so it’s no wonder that the pension plan hasn’t achieved the 7.25% for those longer-dated measurements.

Anyone who has read my blog knows that I am not an advocate of public pension plans making large allocations to alternative investments.  And it’s clear from looking at the pension’s current asset allocation that alternative investments have increased substantially in the past several years.   SEANC blames the increase in alternatives for what they see as the pension plan’s poor investment performance.  SEANC’s contentions are completely wrong.

First, alternatives have not increased under Treasurer Cowell from 5% to 35% as SEANC contends.  When Treasurer Moore left office they stood at 11%[5] under SEANC’s broad definition of alternatives and would have been higher if he had received legislative authority to invested more in hedge funds and private equity.. 

Second, many of the Treasurer’s commitments to alternatives are relatively recent and thus haven’t had enough time to contribute to or hinder the pension plan.  The role of alternatives in driving returns will be determined in the next five or ten years and hasn’t been determined with the release of the third quarter report.

Third, it’s fortunate that Treasurer Cowell and not SEANC is running our pension plan.  SEANC would have committed the state’s pension plan to 65% in equities, which is a level of risk that hasn’t been permitted by the plan’s fiduciaries in the history of the retirement system.  Under SEANC’s stewardship our pension plan would have been rocked during the dot.com bust and credit crisis. 

I am worried about the increase in alternative investments in public pension plans across the country.  Not only are the fees excessive, but too much capital is flowing into hedge funds and private equity all at once.  Moreover, this capital will have to be productively invested as the Federal Reserve raises short-term rates and ends quantitative easing (buying long-term debt).  Thus my apprehension lies in the future.

 While other states and municipalities will have to substantially alter pension eligibility and benefits in order to keep their plan’s solvent, North Carolina is in the enviable position of having a pension plan that can be maintained.  I fear that the misguided analysis provided by SEANC will give opponents of the retirement system the ammunition to lump North Carolina with plans that are grossly underfunded.  I am concerned that as representatives of our State’s employees, SEANC understands so little about one of our state’s most important assets, its public pension plan.




[1] http://www.seanc.org/news/seanc-in-the-news/seanc-statement-on-treasurer-janet-cowells-poor-investment-performance-and-pursuing-a-risky-investment-strategy/
[2] http://www.newsobserver.com/2013/12/05/3436034/seanc-criticizes-cowells-dismal.html
[3] https://www.nctreasurer.com/inside-the-department/Reports/AnnualReport-FY12.pdf at page 23.  See for example, http://www.ncsl.org/documents/summit/summit2013/online-resources/Moody-Adjusted-Pension-Liability-Medians.pdf for a study that shows that NC’s pension liabilities are among the most manageable in the U.S.
[4] https://www.nctreasurer.com/inv/Investment%20Reports/NCRSQuarterlyUpdate-Q3FY13.pdf

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