Friday, August 29, 2014

The Need to Distinguish: The Rhode Island and North Carolina Pension Plans

The Need to Distinguish:  The Rhode Island and North Carolina Pension Plans

I was hoping to leave the question of public pensions and alternative investments alone for a few days.   Then I ran into David Sirota’s article in the International Business Times.  It’s not the article entitled “NC Pension Deal: How Wall Street Ends Up Getting Cash Meant for Main Street,” which appeared August 26, 2014.  I’m still doing research on that one.  It’s Mr. Sirota’s latest effort, “Rhode Island Has Lost $372 Million As State Shifted Pension Cash to Wall Street.”[1]  Mr. Sirota does the same math to Rhode Island’s pension as SEANC and WFAE did to North Carolina’s pension.  He looks at the difference between the median return of all public pension plans and the results for Rhode Island.[2]  

In the case of Rhode Island, Mr. Sirota is on the right track.  State Treasurer Gina Raimondo’s decision to move into alternatives has not produced competitive results.  However, Mr. Sirota makes the mistake of putting North Carolina’s pension into same category as Rhode Island’s retirement system.  Set out below is a comparison of the asset allocation, returns and funded status of the two pension plans.

It doesn’t take an investment expert to see the huge differences between the two plans.  NC has over double the exposure to fixed income, and RI has much 3.5 times the exposure to credit, inflation, and other hedged strategies.  Thus, when we look at NC versus the Wilshire median, it’s fair to say that NC’s exposure to fixed income drove the pension’s relative performance.  In RI’s case, it’s clear that the alternative bet was the most important factor.

In addition, we can see from the funding ratios that Rhode Island is grappling with a major pension problem, while North Carolina has very modest challenges.  Rhode Island also has a very different history when it comes to funding its pension plan.  As recently as 2010, RI was using an assumed rate of return of 8.25%.  Like almost every public pension plan, RI didn’t come close to achieving this return.  In fact, RI earned 7% per year in the last decade (about the same as NC).  They now use a more reasonable discount rate of 7.5%, which is still 0.25% higher than NC’s.  Over the last decade, RI has had a big earnings short-fall and also grossly understated its pension liabilities.  As a result, Treasurer Raimondo had to seek pension reforms because the deficit was (and still is) threatening to the state’s budget.  

Mr. Sirota correctly points out the huge increase in fees being generated in RI and NC by the shift into alternatives.  However, it’s not helpful to lump the two pension systems together.  RI is fully committed to alternative investments and its investment program will succeed or fail based on the results.  Moreover, RI’s weak pension system may not survive if the alternative experiment fails.  Unfortunately the odds are stacked against RI succeeding. 

NC still has time to steer away and moderate its approach to alternatives.  Regrettably, I’m not seeing any signs of moderation or retreat from alternatives.  However, even if NC continues to reinforce its bet on alternatives, it isn’t likely to destroy the pension plan.  Instead, it will make it more expensive for state employees and taxpayers.

While I think it is critical to distinguish between the financial condition and policies of public pension plans, the critics are right about one central point.  There’s only one guaranteed winner in the shift to alternatives: money managers.  They walk away with a big prize no matter the outcome of the game.

[2] The asset allocation and return data for RI are taken from  The actuarial data is from:

Thursday, August 28, 2014

NPR Misses a Chance to Shed Light on North Carolina’s Pension

NPR Misses a Chance to Shed Light on North Carolina’s Pension

WFAE, National Public Radio in Charlotte, ran a two-part series on the state pension plan.  The first part is called “Cowell’s Alternative, Part 1: High Fees, Secrecy Surround Pension Investments.”[1]  The report features charges by Ardis Watkins, legislative director for the State Employee Association of North Carolina, SEANC’s consultant, Edward Siedle, and Ron Elmer, a money manager who ran against Treasurer Cowell in the democratic primary, and a rebuttal by the State Treasurer’s Communications Director, Shorr Johnson.  As I listened to the piece, I was reminded of the old  “Even Stevphen” segment on The Daily Show.  Steve Correll and Stephen Colbert used to take the opposite sides of an issue and yell at each other.  Of course no one yells on NPR, so the WFAE story is the polite version of “Even Stevphen.”

Tom Bullock, WFAE’s reporter, doesn’t sort out the claims of Treasurer Cowell’s critics.  He simply reports them along with Mr. Johnson’s response.  As a result we wind up with a bunch of false claims and weak rebuttals. 

As expected, the critics blame Treasurer Cowell’s commitment to alternatives for North Carolina’s failure to match the performance of the median pension plan in the Wilshire Consulting universe.  As I’ve written on a number of occasions, this contention is wrong.  It’s North Carolina’s traditional commitment to a higher weight in fixed income that is the result.  Set out below is the 2013 asset allocation for the median pension[2] and for North Carolina[3].  As you can see, NC has nearly 10 points more exposure to bonds than the median, and had a one-year return of 15.9% versus 16.9% for the median.  In fact, if you take NC’s return for each of the asset classes and multiply by the weight of the median pension, NC’s return would have been 17.0%.  In other words, if NC had taken the same amount of risk as the average pension, it would have gotten the same result.  Note that NC is 89% funded, while the median plan is only 73% funded.  You can see why the average public pension plan is taking more risk than NC.  They have a much bigger hole to fill.

Mr. Bullock goes on to explore the increase in fees.  The fees have, indeed, increased a great deal, and Mr. Bullock accurately discusses the cost of investing in alternatives.  However, he leads us to believe that alternatives have increased from 5% to 22% during Treasurer Cowell’s tenure.  When Treasurer Cowell took office, the figure was already 10.9%[4] and would have been higher if the legislature had enacted a bill proposed by Treasurer Richard Moore.  In money management, it’s important to get the numbers right.

He also lets Mr. Siedle get away with the following quote:

According to the figures that the treasurer has disclosed to the public, the fees in North Carolina have skyrocketed 1,000 percent over the last 10 years.

Ten years ago when I was CIO the reported fees were $60 million.  In the last fiscal year the management fee was $286 million and total fees were $416 million[5].  That’s an increase of 377% or 593% depending on which figure you use for 2013.  While I’m extremely concerned about this increase, I am even more concerned when a forensic investigator gets the numbers wrong.

Mr. Siedle also makes his much-repeated claim that NC’s pension harbors huge hidden fees buried in its fund-of-funds.  Mr. Bullock reports that Siedle believes these hidden fees may be twice what the state is reporting.  I went through the list of NC’s alternative funds and came up with 19 funds with $1.2 billion of exposure.  That’s only 7.7% of the $15.5 billion in alternative exposure. While I agree wholeheartedly with Ardis Watkins that the State Treasurer should provide the public with detailed information about these investments, we’re not talking about hundreds of millions of hidden fees as Mr. Siedle claims.  I’d be surprised if the average underlying management fee was more than 1.5% given the nature and age of many of these fund-of-funds.  As a result the “hidden” management fees are probably less than $15 million. 

And the amount of incentive payments, known as carry, isn’t likely to be huge.  How do I know?  I examined the performance of each of the fund-of-funds.[6]  The vast majority of this capital hasn’t earned a high enough return to generate any incentive (only 1 of the 19 fund-of-funds earned carry in 2013), so it’s highly unlikely the underlying managers earned much either.  I doubt the underlying managers earned any more than $15 million in carry. In short, a major portion of Mr. Bullock’s reporting and his focus on the fund-of-funds is misleading.  Yes, there are some unreported fees, but not hundreds of millions of dollars as critics claim.

Unfortunately, Mr. Bullock lets Mr. Siedle get away with the following ominous sounding statement:

We literally don’t know where this money is. If anyone can tell you with certainty then I would say get them to guarantee dollar for dollar that money is there. Get them to tell you that money is there. Because I can’t tell you it’s there.

There may be some dodgy investments in NC’s fund-of-funds, just as NC has equity and fixed income investments that haven’t panned out.  However, the idea that the Treasurer, the Chief Investment Officer, the investment staff, and all pension’s consultants and lawyers don’t know where the money is is ridiculous.

Before concluding, I need to give SEANC’s Ardis Watkins credit for making an excellent point about the failure of the State Treasurer to make certain disclosures because the money managers have labeled the information as proprietary or confidential.  Ms. Watkins is right when she says that the money management industry shouldn’t be the ones setting the standard of what the public should see.

In the end, the most disturbing part of Mr. Bullock’s report is that his excellent writing and demeanor given new life to series of attacks on the pension that don’t deserve to be taken seriously.

NOTE:  Part 2 of Mr. Bullock’s report explores Treasurer Cowell’s campaign contributions.  This is another episode of “Even Stevphen.”  Critics charge that the campaign contributions are buying investment mandates, and the Treasurer’s office denies that there are any politics in the investment process.  The critics don’t seem to understand how political influence really works in the world of public pensions, and the Treasurer’s office can’t admit that political considerations make an appearance on some occasions.


Tuesday, August 26, 2014

Off Base Again: Attacks on the NC Pension Plan

Off Base Again: Attacks on the NC Pension Plan

About a week ago the North Carolina State Treasurer announced that the state’s pension assets returned 15.9% in the past 12 months and now top $90 billion.[1]  I’m not a big proponent of trumpeting short-term results because doing so undermines the required long-term focus of managing a public pension.  However, it is customary for every public pension to tout its short-term results, especially when the numbers are positive.

Predictably the State Employees Association of North Carolina (SEANC) took the opportunity to disparage the results by pointing out that North Carolina underperformed the average large public pension plan in the last 12 months.[2]  SEANC seems to make this argument several times a year, and each time they completely miss the reason why North Carolina underperforms the average pension plan during a sharply rising stock market.  As I’ve said repeatedly, it isn’t alternative investments (at least not yet) that are the reason why our pension plan trails the average plan. See “A Misguided Analysis of Pension Returns” (December 11, 2013) for a detailed discussion.  North Carolina continues to carry a greater weight in fixed income than the average pension plan.

What’s strange about SEANC’s latest critique is that it criticizes the State Treasurer for not investing more in equities.  Much like an unsophisticated retail investor, SEANC is lured by the short-term performance of the stock market.   The 24.7% return in equities for the past 12 months has SEANC yearning for more equity risk.  If we’d followed SEANC’s prescription (even with index funds) over the past 15 years, the state’s pension plans would be in a very deep hole.  Equities only returned 5% during that period (including the big rally in the last couple of years).  Fortunately, the pension was exposed to fixed income, which returned 6.9% over the last decade and a half.

SEANC also hits the Treasurer for highlighting the fact that the state’s pensions now have $90 billion in assets.  According to SEANC, this is merely the result of state employees contributing 6% of their paychecks and taxpayers kicking in another 9%.  This assertion is also wrong. 

·      First, the 6% and 9% contributions only apply to the Teachers’ and State Employees’ Retirement System (TSTRS) pensions (roughly 70% of all NC pensions).  The other pensions, most notably Local Government Employees’ Retirement, use a different formula. 

·      Second, it’s only in the last couple of years that the taxpayers’ contribution has been even close to the 6% employee payment.  Since 2001 state employees and teachers have contributed $9.0 billion to the pension system, while taxpayers have chipped in $5.1 billion.  In order to balance the state budget, the legislature has let the long-term pension deficit slowly rise instead of keeping up the taxpayer contribution.  It’s a policy choice that may come back to haunt us one day.

·      Third, the employee and taxpayer contributions are largely necessitated because retirement payments are escalating.  Since 2001, the TSERS has paid out $32.4 billion in benefits.   In my first year as CIO, the TSERS paid out $1.8 billion in benefits.  In the last fiscal year, those benefits were $3.7 billion, and are likely to top $4 billion this year.

·      Fourth, and this is the part SEANC really doesn’t want to talk about, the number of active members in TSERS has fallen from 349,000 in 2001 to 320,000 in 2013 (-8%), while the number of retirees has grown from 112,000 to 180,000 (+61%).  During this period compensation has been stagnant.  Meanwhile our state’s population has grown from 8 million to 9.8 million (+23%).   In other words, the burden of the 6% contribution by state employees and teachers is the result of a failure by the taxpayer to support public employees and their wages.  It’s also a failure of SEANC to defend its constituents.  The remaining teachers and state employees have carried a heavy burden as the retirement rolls rise, and the employer contributions remained relatively small.

·      Fifth, no matter how a pension plan allocated its assets, the capital markets did not return anything close to the assumptions of even the most conservative pension plans.  For the past 10 to 15 years, almost any basket of stocks, bonds, and alternatives returned between 6% and 7%, and that wasn’t enough to keep pensions from having larger deficits. It’s only been in the wake of the financial crisis that risky financial assets have rebounded.

SEANC isn’t the only one making off-base assertions.  Their consultant, Edward Siedle, recently suggested that North Carolina would be better off paying Treasurer Janet Cowell a billion dollars just to go away.[3]  He asserts that the Treasurer’s foray into alternatives is so disastrous that our State would come out ahead if we bought out the State Treasurer in order the pave the way for purging our pension of alternative investments.  While I have growing concerns about the excessive use of alternatives by North Carolina and most other public pension plans, I don’t think we get very far by making ridiculous proposals. 

However, the members of SEANC might take up Mr. Siedle’s idea on a more modest  scale.  They might be better off paying SEANC not to lobby on their behalf.  SEANC’s track record isn’t very good, and its attack on the pension plan is only giving opponents another reason to gut the pension.