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.


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