Monday, August 31, 2020

If you are making bets, you’d better have a crystal ball: the NC public pension

 If you are making bets, you’d better have a crystal ball:  the NC public pension

“We don’t have  a crystal ball and we don’t gamble with the money of those who teach, and otherwise serve the people of North Carolina.”  Treasurer Dale Folwell made this statement recently and he has said it throughout his tenure.   I think it is a sensible statement, if that’s what you genuinely believe.  Few among us are good at forecasting the future and I have yet to meet anyone who can consistently predict the future direction of individual securities or financial markets.   However, Treasurer Folwell’s statement is completely inconsistent with his investment decision-making.  Although he claims that he can’t see the direction ahead for the financial markets, he acts as if he has extremely strong convictions about where markets are headed.

Why else would Treasurer Folwell  have liquidated large positions in equities in 2017 and 2019?   He must be peering into a crystal ball and see stock prices declining.    Why would he maintain a large cash position in the pension’s bond portfolio?  He must believe the interest rates are going to rise.   

If the State Treasurer really believed that he doesn’t have a crystal ball, he would be strictly adhering to his investment policy.    The whole purpose of an investment policy is to provide broad exposure to financial markets at an acceptable level of risk.  The only time an investor should deviate from the policy is when they have a particular insight and a strong level of conviction.   In other words, a crystal ball.

This lesson applies to the average investor.   For example,  unless you have a strong conviction about a particular portfolio manager (e.g., active investing), you ought to own index funds.  The evidence shows in no uncertain terms that you will have better returns from an index than the average active manager who is making bets on certain stocks and sectors of the markets.

Set out below are the Treasurer Folwell’s asset allocation  versus his investment policy as of June 30, 2020.  The pension is ten percentage points below its target allocation for public equities (32% versus 42%); this is a big gamble.  It is four percentage points (32% versus 28%) above its target for fixed income; this is another sizable bet.   The pension is eight percentage points (9% versus 1%)  above its target for cash; this is perhaps the most imprudent of all of Treasurer Folwell’s speculations.   The State Treasurer says that he doesn’t gamble and he doesn’t have a crystal ball.   Each one of these major deviations to the investment policy is a gamble using a crystal ball that doesn’t work.

In the next few days, I will explain why cash is a gamble and not a safe investment in a pension plan. 

North Carolina Pension Plan Asset Allocation 6/302020

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