The Failure of Market Timing: The North Carolina Pension Plan
If there is one lesson I have learned in nearly forty years as a professional investor, it is not to time the
financial markets. Markets are entirely unpredictable. There’s no better example than the effort by
State Treasurer Dale Folwell to play hedge fund manager with the assets of North Carolina’s public
pension plan. In recent days the State Treasurer released second quarter results for the pension, and
the results are disappointing and completely at odds with the State Treasurer’s own investment policies.
No one should read too much into a quarterly investment report, but the NC pension only
returned 6.4% rather than the 8.9% return for its implementation benchmark and 11.5% for its long-term
policy benchmark. Over the last 12 months, the pension returned 4.4% versus 3.6% for the
implementation benchmark and 6.2% for the policy benchmark. /1
In a properly managed pension plan the implementation and policy benchmarks should show pretty
similar results. The policy benchmark represents the returns that would have been achieved if the
pension followed its investment policy. The implementation benchmark shows how the pension’s
investment managers and professional staff executed their mandates given the capital allocated
by the State Treasurer. What we see is that managers and staff have done their jobs; the pension’s
returns exceed the implementation benchmark. Meanwhile, Treasurer Folwell has not met his
responsibility; the pension’s returns trail the policy benchmark by wide margins.
The culprit is the State Treasurer’s attempts at market timing and the $12 billion in cash that he’s
stockpiled. /2 As I’ve written previously, Treasurer Folwell sold $16 billion in equities in 2017 and
2019. For a brief period in April it appeared that his huge wager might pay off as global equity prices
plummeted. However, the equity markets have shrugged off the economic consequences of the
coronavirus and rebounded. The Treasurer’s decision to ignore and violate his own investment policy
has cost the pension nearly $3 billion because market timing requires two correct decisions, not
one. /3 To succeed a market timer has to sell at or near a market top and reinvest at or near the
market bottom. Treasurer Folwell has failed on both counts.
Incredibly, the State Treasurer also played hedge fund manager during the second quarter. At the end of March, Treasurer Folwell purchased $1.5 billion in equities. Six weeks later he sold $1.5 billion in equities. /4 While his trade resulted in a short-term gain of about $300 million, he left another $200 million on the table. This is no way to manage a long-term investment like North Carolina’s $103 billion pension plan. /5 Any prudent investor would be focused on the long-term objectives of the pension and the strategic asset allocation required to meet those objectives. The sole fiduciary for a large public pension plan should not be a hedge fund trader.
The North Carolina General Statutes require the State Treasurer to maintain an investment policy for
the pension plan. While the State Treasurer has such a document, he has rendered it worthless
because he’s ignored and violated its provisions. The written policy calls for public equities to be
in a range between 37% and 47% with a target of 42%. As of June 30th, the pension had 33%
invested in equities. /6 Treasurer Folwell has been in violation of his written policy for over three
years. He should have rebalanced the pension portfolio by buying equities for nearly three years as
his staff urged him to do when he first undertook this misguided enterprise. /7 With $12 billion
allocated to cash, which earns about 1.5% per year, the State Treasurer has locked in a short-fall that
will cost taxpayers, state employees, and retirees for years to come.
I suspect the State Treasurer shares my view that equity valuations are uncomfortably high. If he
had followed the investment policy, he would have been selling equities in recent days and weeks
in order to bring the allocation back within its target allocation. Instead he has cost the pension
$3 billion, destroyed the pension’s investment policy, and left the plan without a roadmap.
1 Quarterly Investment Report for the Period Ended June 30, 2020, page 4. https://files.nc.gov/nctreasurer/documents/files/IMD/InvestmentReports/QuarterlyInvestmentReports/qir-2q2020.pdf
2 IAC Performance Review, pages 9 and 39. The pension had $9.7 billion listed in cash and another $1.8 hidden within the fixed income portfolio. https://files.nc.gov/nctreasurer/documents/files/IMD/MeetingDocuments/8-19-20_iac_performance_presentation.pdf
3 The $3 billion loss is my conservative estimate based on the sale of $7.2 in equities in 2017 and $8.5 in 2019. The proceeds were invested in cash and bonds. I estimate that the sales cost the pension $4.2billion, offset by $1.1 billion in gains from the investment in cash and bonds.
4 IAC Performance Review May 20, 2020, pages 28, 31. https://files.nc.gov/nctreasurer/documents/files/IMD/MeetingDocuments/5-20-20_iac_performance_presentation.pdf