Wednesday, July 24, 2013

The truth about the NC pension fund's inflation portfolio.

A must read on how the NC Pension Fund is loading up on commodities.   These "assets" aren't investments - they are merely directional bets.  The new SB 558 would allow $6 bn of these gambles.    

Proponents of commodities argue that they are inflation hedges - that they should go up when inflation increases.   While many commodities are correlated with inflation, the risk return trade off is frequently terrible.   You are getting a bit of diversification at a big overall risk.   Top that off with high fees and they are a drag on the overall portfolio.  

Surprisingly to many - one of the best inflation hedges are common stocks - but that's a post for another day.  


Monday, July 22, 2013

SB 558 will result in a 42% increase in fees to Wall Street

Based on a very thorough analysis which seems pretty reasonable, the revised SB 558 authorizes the Treasurer to increase alternatives to such a degree that fees to Wall Street would go up by 42%.  
You can read the full analysis here.  


SB 558 is a bad idea - and this isn't a partisan issue.  Passing this bill will just waste more millions on bad investments.  






Thursday, July 18, 2013

How expensive are alternatives?

My friend Ron took the time to estimate the expense ratio for various asset classes in the NC Retirement System.   You can see his excellent full discussion here.



Public equity and bonds are at pretty reasonable rates - 0.46% and 0.01%, although I pay less in my 401-K for my stock portfolio, so I still think 0.46% is pretty high.

But the real shocker is in the alternatives space.   Here the fees range from 1.01% to 1.78%!  The worst offender being pure "Alternatives" which includes hedge funds.   Oh, and this category earned a 5.53% in return.

There is no excuse for this.  This is a handout to Wall Street from the tax payers of North Carolina - plain and simple.

Wednesday, July 17, 2013

State Pension Fund and my experience with the legislative process.

Today the house finance committee met to discuss the SB 558 which would increase the possible allocation to alternatives for the pension fund.   I blogged on this yesterday.  A friend and I decided to go downtown to see the action.   The bill had been voted on in the senate and had passed almost unanimously.  Next it was heading to the house via some potential revisions at the house finance committee.   (All this is new to me - but I had a lesson in NC civics this morning!).

I decided to speak up and voice my concern (as a concerned tax payer) that moving to more alternatives will not generate higher returns, but will lead to much higher fees.   The vote was close - 14-13 in favor of the bill - and was reported (and tweeted by) Pensions and Investing Magazine.

But all is not lost - I also got to meet some of the Democratic Caucus and (separately) the leader of the Senate - Phil Berger - to express the concerns about these very high fee investments.  These products are not a guarantee of higher returns - in fact quite the opposite.  Hopefully these folks will be able to stop the passage of this bill.

Anyhow, the legislature session is winding up, so we'll see what happens.


Tuesday, July 16, 2013

NC Senate Finance Committee to consider Alternative Investments Bill tomorrow.

The proposal by the NC State Treasurer to increase the alternatives allocation in the State Pension Fund continues to make its way through committee.   The details of the bill are here.  As I've blogged before, this bill allows the State to invest up to 40% in private equity, real estate and hedge funds.  Treasurer Cowell, appearing on CNBC, argued that the poor outlook on bonds makes alternatives an attractive option.

I respectfully disagree (and others share my view).  Alternatives, and in particular - hedge funds and private equity - are very risky, have very high fees (2% + 20% of all profits is not uncommon), are very illiquid (you can't get your money out), and are very opaque.  On top of that there is little evidence that they outperform more conventional investments.  Hedge funds rely heavily on borrowed money to boost returns - and thus are also sensitive to interest rate increases that could hurt traditional bond portfolios (a point made by Andy Silton today).

The solution to the State's pension shortfall is to slash the hundreds of millions that it pays to Wall Street managers, and to manage the portfolio in passive manner.   This is the only way that will give the Fund a fighting chance of meeting the retirement needs of North Carolina's public employees.

It is worth noting that Ms. Cowell raised the fifth largest campaign fund in the 2012 election.  A total over $1 million.   What is particularly interesting is that one third of her campaign contributions came from "Lawyers and Lobbyists".   Perusing the list of donors is quite enlightening - a great many are from law firms in the north east.   This begs the question - "why are New York lawyers funding the State Treasurer race in NC?"   I obviously can't comment on anyone's personal motivation, but I will note that investing in hedge funds and private equity is very unlike buying stocks.   These investments are very idiosyncratic and require a great deal of legal advice to create the investment contract.

Until recently, investment advisors could make big campaign donations to political campaigns, but the SEC "pay to play" rule took care of that influence.   It would seem time for the SEC to expand this ruling to include securities and investment law firms as well.




As I've stated before, this blog represents my personal views and not that of my employer. Furthermore, I write this blog on my own computer at home.


Thursday, July 11, 2013

Inflation adjusted Dow

An interesting graphic from "The reformed broker" showing the Dow 30 adjusted for inflation.  


In real terms it appears that we haven't made much real progress in recent years - however I would point out that this chart only shows the level of the index (which is a price index only) and thus ignores the rather healthy dividend yield of about 2.5%.  So to say that the Dow has not made real gains against inflation would be a bit of a misstatement.



Sunday, July 7, 2013

NC Pension Fund managers challenge Moody's assumptions...

Moody's has conducted an evaluation of all state pension funds and the good news is that North Carolina's is in better shape than most.

However, the state pension fund is still facing a funding gap - the difference between what the plan owes and what is in the plan.  

The question is how big is this funding gap?

The answer is that it depends on who you ask...Moody's claims that the the gap is $7.48bn, while the State of NC reckons that it is around $3.7bn.

This difference in estimates is in part due to how the State and Moody's calculate the present value of the liabilities of the fund.  While the State uses the target return of the fund of 7.25%,  Moody's uses the rate on risk free securities.   By using a lower rate, Moody's computes a larger liability and hence a larger funding gap.   I've discussed this issue before.

So who is correct?   The State is taking issue with Moody's and correctly argues that they are following the accounting rules.  The problem is that it is the rules themselves that are at fault.   The liability that the state faces to its retirees is very low risk - it is virtually a certainty.  Therefore, this liability should be discounted using a discount rate that reflects this level of risk.   7.25% is far too high, and a more reasonable rate would be the yield on the long term bonds issued by the state which is in the 3.4-4.5% range - this is basically what Moody's used.

By arguing that Moody's estimate is wrong, the State is blurring the real issue.

The article quotes Andy Silton, whose excellent blog is a great resource for anyone interested in state finances.