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.




[1] http://www.ibtimes.com/rhode-island-has-lost-372-million-state-shifted-pension-cash-wall-street-1671790
[2] The asset allocation and return data for RI are taken from http://treasury.ri.gov/documents/sic/SIC-07-14.pdf.  The actuarial data is from: https://d10k7k7mywg42z.cloudfront.net/assets/52b87b3ed6af6834f90002c8/ERS_VAL2013.pdf

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