Thursday, October 15, 2015

All or None Isn’t A Good System of Governance: North Carolina’s Sole Fiduciary

All or None Isn’t A Good System of Governance:  North Carolina’s Sole Fiduciary

A couple of days ago Janet Cowell decided not to run for reelection as Treasurer of North Carolina.[1] As a result we will have an open election in 2016 to select someone to act as the sole fiduciary for the state’s $90 billion public pension plan.  Although the North Carolina State Treasurer has a myriad of responsibilities, the stewardship of the pension plan probably has the greatest long-term consequences for the financial well-being of the state and the retirement security of civil servants.

The North Carolina Constitution does not specify any particular substantive qualifications for the position of State Treasurer (it only provides that the Attorney General has to be a lawyer[2]).  Thus, the voters, state employees, teachers, and first responders are about to engage in a risky proposition.  They’ve got to hope that the next Treasurer has financial experience, reasonable judgment, and an honorable character.  Moreover, they’ve got to trust that the next Treasurer will keep political influence to a minimum.

Unfortunately, the election process does not lend itself to selecting a candidate based on the requirements of the job.  The next Treasurer will be largely determined by the party affiliation of the next President and Governor of North Carolina.  The particular qualifications of the Republican and Democratic contenders will hardly matter.  Even if a candidate were eminently qualified, it would be next to impossible to properly inform the voters in the cacophony that is a general election.

No one would retain a money manager for her personal accounts or retirement savings via an election process.   No one would invest in a mutual fund if the portfolio manager were selected by the vote of the general public.  And yet anyone who pays the filing fee can run for State Treasurer and the job of investing $90 billion.

Fortunately, North Carolina has had three good treasurers in the last fifty years.  Harlan Boyles, Richard Moore, and Janet Cowell have been reasonable stewards of the pension plan and kept political influence to a tolerable level.  A quick aside: anyone who thinks that there isn’t some level of politics involved in the investment decisions of pension assets is terribly naïve.  North Carolinians can only hope that their string of luck continues.

Well over a year ago, Treasurer Cowell appointed a commission to look at this very question and propose alternatives to the sole fiduciary model.[3] Regrettably Treasurer Cowell never took up any of the commission’s proposals either to enhance the role of the existing advisory committee or create a board of trustees to share control over pension investments. 

Investment boards are far from perfect.  As I’ve described in recent posts, the boards at CalPERS and CalSTRS don’t seem up to the task of overseeing their pensions’ private equity exposure.  Moreover, there are all too many instances when public pension boards have endorsed strategies or hired managers based on faulty information or political influence.  Nonetheless, I have come to the view that it is riskier to empower a single elected official rather than appoint a board to oversee billions in pension assets and dole out hundreds of millions of dollars in management fees.  On a board there’s some chance that a dissident or two will speak up when investment policy steers off course.  For example, at CalPERS  J.J. Jelencic has single-handedly forced the nation’s largest public pension to examine the true costs of its private equity program.  And California State Treasurer John Chiang, an ex-officio member of CalPERS and CalSTRS, has introduced a proposal to force the pension plans to make better disclosure  (My friends at Naked Capitalism have done an excellent analysis of Treasurer Chiang’s proposal, as well as its short-comings[4]).

When Treasurer Cowell leaves office in early 2017, North Carolina will undergo a complete turnover of the decision-making process.  In all likelihood, the new treasurer will hire a new CIO and replace one or more of the professionals overseeing a particular asset class.  These changes will drain the pension plan of its institutional memory and disrupt one or more long-term investment programs.  A board better preserves institutional memory and continuity because trustees tend to depart and join one at a time.

I’ve been a critic of Treasurer Cowell’s big commitment to alternative investments and her program to direct investment into North Carolina.  The Treasurer is far from alone in pushing the pension plan in this direction.  Almost every large public pension plan is drinking the alternative investment Kool Aid being served up by hedge fund and private equity managers, and many plans are trying to steer investments into their home states.  While I disagree with these policies, I continue to believe that North Carolinians were well-served by Treasurer Cowell.

I don’t expect Treasurer Cowell to reverse course on alternative investments or in-state investments during the remainder of her term.  However, I hope she will become an advocate for a board of trustees to oversee the investments of our public pension.   The next State Treasurer will be the sole fiduciary of the pension’s investments.  Let’s hope the eventual winner is the last sole fiduciary.

[2] North Carolina Constitution, Article III, Section 7(7)

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