Friday, July 14, 2017

North Carolina’s pension cuts fees and hurts its prospects

North Carolina’s pension cuts fees and hurts its prospects

This afternoon David Ranii, business reporter for the N&O, provides a very clear and evenhanded report of the State Treasurer’s efforts to cut management fees in the North Carolina pension plan.  His story also discusses some of the repercussions in a story aptly entitled “Will aggressive fee-cutting at the state pension fund lead to lower returns?[1]    On October 1, 2016, State Treasurer Dale Folwell told the New & Observer,  “The first thing I’m going to do is cut $100 million out of the financial management fees that state employees now pay[2]” Within six months of taking office, Treasurer Folwell is well on his way to meeting his promise by terminating thirteen active equity mandates. I wholeheartedly endorse the proposition that a portfolio of active equity managers cannot add value to a pension and the fee reductions associated by eliminating these mandates.  However, as I’ll detail in a series of posts next week, the State Treasurer has made a series of missteps that should be avoided by retail and institutional investors alike.

1.     Long-term investors should not try to time the markets.  In order to meet a distant financial objective investors are best served by sticking to a strategic asset allocation that enables them to met their liabilities.  In terminating thirteen managers and removing $7.4 billion from the pension’s equity portfolio, the State Treasurer is making a big bet that he has the ability to time financial markets.  As Warren Buffet has said on numerous occasions, market timing is the number one mistake made by investors.

2.     Reducing management fees is an appropriate goal, but an investor needs to account for all the costs associated with fee reductions.  Mr. Ranii’s reporting clearly shows that transactions and opportunity costs swamp the fee savings touted by the State Treasurer.  Unless the Treasurer gets extremely lucky as a market timer, his fee reduction initiative will cost the pension $350-$450 million.

3.     There’s a seeming inconsistency in the State Treasurer’s terminations.  Among the thirteen managers, three also manage money for the Supplemental Retirement System (401(k), 457).  Not only were they retained, but the three managers were recommended by the State’s Chief Investment Officer for new options in the SRP.  While the Treasurer isn’t sole fiduciary for the SRP, he is chairman, and his staff oversees that program as well as the pension.

When Mr. Ranii asked the State Treasurer about my critique, Mr. Folwell questioned my objectivity and suggested my analysis was relying on looking through the rearview mirror.  I’ll readily admit that despite my best efforts, I’m not always objective.  I have not been associated with the pension plan in twelve years, and have been retired for over five years.  I have no insight into any of the state’s money managers and no opinion on whether they should be retained or terminated. 

My view on the State Treasurer’s action in terminating thirteen managers and reducing $7.4 billion in equities (8% of the pension’s assets) is purely forward looking.  Here’s the simple back of the envelope math based on the Treasurer’s own assumptions.  The pension plan is supposed to earn on average 8% from stocks, 2.5% from bonds and 2% from cash.  If 8% of the assets are no longer in equities and earning the lower yields of cash and bonds, it’s going to cost the pension about 0.5% per year in performance, or $425 million.   

More next week.


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