Tuesday, April 21, 2015

The NC Pension Plan Approaches $500 Million in Fees; SEANC has been Muted

The NC Pension Plan Approaches $500 Million in Fees; SEANC has been Muted

I have finally found a reason to write about the departure of Dana Cope from his position as Executive Director of the State Employees Association of North Carolina (SEANC).  For those of my readers who are not acquainted with this saga of political intrigue in North Carolina, Mr. Cope used SEANC funds for his personal use.  He left the organization a couple of months ago.

Loyal readers may recall that Mr. Cope was highly critical of our state treasurer’s stewardship of the state pension plan.  Last year, Mr. Cope made a massive public records request and hired a consultant to evaluate the pension.  Sadly, the consultant’s report was long on hyperbolic rhetoric and short of proper analysis.  Moreover, the public records request was a political stunt.  Mr. Cope forced the Treasurer’s office to produce tens of thousands of pages of deal documents without having any intention of evaluating the material.

I am writing about Mr. Cope and SEANC because we could sorely use their voices in acting as a constructive critic of the investment practices of the North Carolina pension plan.  Unfortunately, Mr. Cope was never interested in being a constructive critic, and now SEANC has been deeply wounded by Mr. Cope’s alleged misconduct.

In the last couple of days, the North Carolina State Treasurer posted the department’s annual report for fiscal 2014.[1]  The good news is that the North Carolina Retirement System remains in good shape.    Continued funding by employers and employees together with ebullient financial markets has combined to keep the retirement plans reasonably well funded.

However, the report also shows that the state’s public pensions are spending more and more on money management without getting nearly enough back in return.  The pension plan paid out $490 million in management and incentive fees, an increase of 18% over the prior fiscal year.  Pension assets increased by 13% to $90.1 billion, and the fund earned a return of 9.5%.  While taxpayers and pensioners enjoyed a reasonable year (thanks mostly to rising markets), money managers had an outstanding year.  By the way, this information is dated because it only covers the period ended June 30, 2014.  It’s hard to see why it should take ten months to put out basic information about the fees and expenses of the state’s pension.  Presumably the state treasurer and her staff had this information six months ago.

The report shows that the foray into alternatives has produced some winners, such as a portfolio of credit strategies, and some losers, such as a collection of inflation strategies.  However, the largest alternative allocations, private equity and real estate have failed to beat their benchmarks over most reporting periods.  Meanwhile, the plain vanilla allocations to stocks and bonds continue to move along in concert with their respective markets.  Not surprisingly, the state’s vast collection of money managers produce market-like returns, and active management of the pension doesn’t produce any meaningful value.

As the table below shows, the treasure-trove of fees generated by the pension plan isn’t evenly distributed.    For example, credit managers received over one-quarter of the fees, even though they only manage 8% of the assets, while global equity managers received 22% of the fees even though they manage over two-thirds of the assets.  Credit managers generated $78 million in performance fees because their short-term performance was above their benchmark.  Unfortunately for beneficiaries and taxpayers, those credit managers won’t have to return any of that wind-fall when credit eventually falters.

Percentage of fees earned and assets managed by asset class (FY 2013-14)

As of yet, the Treasurer’s office hasn’t issued a supplementary report showing details of the performance and fees generated by individual managers.  However, I went back to the public records request made by the SEANC to see if could get gain any insight into how credit managers earned those performance fees.  Unfortunately, the Treasurer’s office never released the documents for most of the credit managers.  Among the handful of credit managers whose documents are on the SEANC website, most claimed a proprietary exemption and redacted the incentive fee formula.    In process of trying to find some indication of how credit managers earn their incentive, I ran across the most ridiculous redaction I’ve seen to date.  Highbridge Capital, the manager of something called Highbridge Principal Strategies Irish Specialty Loan Fund III PLC, claimed that entire documents should be redacted.    I’m astounded that the state treasurer’s professional staff accepted this absurd claim.  I’ve included the relevant excerpt from an email below.

The fees generated by the pension plan are going to continue to rise as the state treasurer moves further and further into alternative investments.  While these strategies won’t bankrupt the pension plans, they will cost taxpayers and/or beneficiaries billions of dollars over the next decade.    In recent years, our legislature has endorsed this strategy. 
As a result, there’s no effective check to this continued move into alternative investments.

This is where the SEANC comes back into the picture.  They should be tearing apart the annual report and asking questions.  Instead they have been discredited and are focused on sorting out the damage wrought by their former executive director.

[1] https://www.nctreasurer.com/inside-the-department/Reports/NCDST_AnnualReport-FY2013-2014.pdf

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