Wednesday, September 17, 2014

Chasing Campaign Contributions Down a Rabbit Hole: New Jersey’s Public Pensions

Chasing Campaign Contributions Down a Rabbit Hole:  New Jersey’s Public Pensions

In what’s becoming a standard and distracting ploy, the AFL-CIO in New Jersey has filed a complaint with the State’s Ethics Commission complaining that a group of money managers made campaign contributions in contravention of the State’s ban on such contributions by money managers.[1]  The letter cites five instances of abuse, but as Dan Primark of Fortune’s Term Sheet correctly points out, only one of these instances may be an actual violation of New Jersey’s prohibition.[2] 

The one instance involves a $10,000 contribution by a part-time executive at General Catalyst Partners to the State Republican Committee.  That part-time executive, Charlie Baker, is running for Governor in Massachusetts, so his contribution has become a hot political issue.   According to Fortune, New Jersey’s Investment division has sold its $15 million investment in the fund in order to remedy the violation.  Just as with SEANC’s complaints about the North Carolina pension, the AFL-CIO is highlighting the wrong issue and diverting attention from what’s really endangering the public pensions of New Jersey. 

For starters, New Jersey’s pensions are grossly underfunded. I’ve been reading the state’s actuarial reports going back to the early 2000s and have found that there’s a consistent pattern by Republicans and Democrats of underfunding public pensions.  When Governor Christie attempted a modest reform, all he was able to come up with was an increase in the employee contribution and a new formula that pushes out the accumulated deficit beyond the Governor’s life expectancy, let alone his political career.  His reforms didn’t work, and he refused to make the contributions needed to keep the plans from deteriorating further.  As a result he’s feeling the wrath of the unions and downgrades from the rating agencies. 

Investments played a role in this debacle.  For starters New Jersey used ridiculously high assumptions for their investment returns.  For most of the 2000s they used an assumption of 8.7%, which was only reduced to 7.9% recently (which is still to high).  When the capital markets failed to deliver those kinds of returns, the deficit grew. 

The investments themselves also proved disappointing.  In the early 2000s, New Jersey was heavily weighted in domestic large cap equities.  When the Internet bubble burst, the portfolio suffered.   Rather than allowing the portfolio to recover, Governor Corzine pushed New Jersey into alternatives.   His administration’s decision and his Goldman Sachs heritage set off a stampede through the tunnels under the Hudson.  Almost all of New Jersey’s investment had been internally managed, so the shift into alternatives meant that money managers had a huge opportunity to generate fees without having to compete with incumbent managers.  Between 2005 and 2013, NJ went from no exposure to alternatives investment to over $20 billion in more than 200 separate portfolios.  Last year, NJ finally revealed the management fees for this exposure.  In 2013, NJ paid alternative managers $378 million in fees (not including incentives or carried interest) or 1.86%. 

Are politics at work inside the pension plan?  Of course.  However, it isn’t the petty stuff of $5,000 or $10,000 campaign contributions.  If critics and the unions want to fight Governor Christie on the legality of campaign contributions, they are going to lose.  While the Governor may suffer a political wound, it won’t make the pension any sounder.  As I’ve written on numerous occasions, many of the money managers who manage assets for New Jersey and a host of other public pension plans are involved in politics at a national and even global level.  Mr. Baker’s $10,000 campaign contribution is a distraction.  In 2013, the $15 million commitment to General Catalyst was worth $4 million or 6/1000th of one percent of New Jersey’s pension assets.  This valuation wasn’t because the investment has done poorly. Rather, General Catalyst had yet to draw down the full commitment.  In fact, it appears that the investment is doing well.  Unfortunately, the pension plans have been forced to sell the investment.  While Fortune reports that NJ made a profit on the sale, the forced sale won’t come close to the return they would have earned if they’d been able to hold on to the fund.[3]  In any event, NJ’s investment staff has wasted a great deal of time on a tiny investment instead of addressing the real problems that are threatening the pension’s future. 

New Jersey’s public pensions have gone from being a manageable challenge to a serious problem within a decade’s time.   The attached chart shows the steady decline of the state employees pension from 100% funded at the turn of the century to less 50% funded according to the latest annual report.  Given some of the assumptions and practices employed in NJ, the deficit is certainly larger than those in the official reports.

Potentially illegal political contributions create great headlines and make politicians look bad.  However, politicians are pretty adept at dodging this sort of issue and using it to divert our attention from the real issue, which is their failure to properly manage and fund public pensions.



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