Wednesday, August 27, 2014

Wednesday, June 4, 2014

Bravo NC Treasurer Cowell! (Yeah, I said it.)

     I was hopeful when the State Employees Association of North Carolina (SEANC) turned up the heat on North Carolina State Treasurer Janet Cowell to make changes to the North Carolina Retirement System (NCRS) pension investment operations and reporting by hiring professional pension investigator Ted Siedle and his firm Benchmark Alert.  I was hopeful when Treasurer Cowell announced the formation of the Investment Fiduciary Governance Commission to evaluate the State Treasurer's management of the NCRS.  I was hopeful when Treasurer Cowell's Governance Commission issued recommended changes that addressed many of Mr. Siedle's concerns and echoed many of my suggestions.  Hopeful, but skeptical.  

Thursday, May 15, 2014

SEC: 50% of Private Equity Firms Steal from their Clients

Andrew Bowden, the Director of Compliance Inspections and Examinations recently gave a speech entitled, "Spreading Sunshine on Private Equity."  If you click on the link and read the transcript from Bowden's speech, you would have to wonder why anyone would ever give their money to a private equity fund ever again.  Bowden's speech should be required reading for all pension fund managers.  What follows is a quote from Bowden's speech:

"When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50% of the time.  This is a remarkable statistic."
The SEC has found in their audits of private equity firms that more than 50% of them:

  1.  over charge their clients for fees, and 
  2.  improperly reimburse themselves for their expenses from the companies they acquire.  

Both maneuvers essentially mean they take money that is rightfully their clients money.  In other words, they are thieves.

Another astonishing quote from Bowden's speech:
"The private equity model is very different [from publicly traded stock portfolios].  A private equity adviser typically uses client funds to obtain a controlling interest in a non-publicly traded company.  With this control and the relative paucity of disclosure required of privately held companies, a private equity adviser is faced with temptations and conflicts with which most other advisers do not contend.  For example, the private equity adviser can instruct a portfolio company it controls to hire the adviser, or an affiliate, or a preferred third party, to provide certain services and to set the terms of the engagement, including the price to be paid for the services ... or to instruct the company to pay certain of the adviser’s bills or to reimburse the adviser for certain expenses incurred in managing its investment in the company ... or to instruct the company to add to its payroll all of the adviser’s employees who manage the investment." 
Let me summarize that paragraph.  Bowden is saying that private equity managers use their client's money to buy businesses. Once they control the business, they proceed to rob it.  What an incredible business model!  Use someone else's money to buy businesses so that you can rape and pillage the business for your own benefit.

Lastly, Borden points out that Bruce Karpati of the SEC's Enforcement Division has found that many private equity funds lie to their clients about the valuation of their investments.  This also boosts fees which is another way to steal from their clients.
"Last year at this conference, Bruce Karpati, then of the SEC’s Enforcement Division, addressed this debate, noting the importance of valuations in fund marketing.  Academic studies have supported this thesis, showing that some advisers inflate valuations during periods of fundraising...A common valuation issue we have seen is advisers using a valuation methodology that is different from the one that has been disclosed to investors....."
One would have to wonder how any pension fund manager could possible ponder investing in private equity funds without inherently violating their fiduciary duty to their pensioners?

Tuesday, March 4, 2014

Monday, February 3, 2014

Politics Already at Play Within North Carolina Pension

What follows was my letter to the editor of the Raleigh News & Observer that was published on page 2 of the Work & Money Section of Sunday's paper on 2/2/2014.  My letter was a response to Andrew Silton's column from the prior Sunday's News & Observer. 

Mr. Silton’s Jan. 26th column, “Keep politics out of pensions” was sparse on facts.  I’d like to add some.

The last annual report issued by Treasurer Cowell shows the state pension funding status to have fallen from 112.8% in 2000 to just 94% now.  That is to say, it is 6% UNDER-funded.  That’s roughly a $4 billion shortfall.  But, Treasurer Cowell knows the government pension accounting standards are flawed and about to change.  A Buck Consultants report says the pension will be just 86% funded under the new rules.  That’s 14% under-funded, or roughly $8 billion.  However, the nation’s leading expert on public pension funding, Stanford Professor Joshua Rauh, argues that public pensions should calculate funding status in the manner corporate pensions are required. Professor Rauh estimates North Carolina is $38 billion under-funded.  That is roughly the equivalent of two years of North Carolina tax receipts. Professor Rauh will lecture at NC State University on April 16.  I suggest Mr. Silton and Treasurer Cowell both attend.

As of 6/30/13, the annualized 10-year investment performance of the state pension of 6.6% lagged the median public pension return of 7.4%.  The underperformance of 0.8% per year for 10 years for the $83 billion pension fund translates into lost returns of $6 billion.  And, that is the cost of not being merely average.  Plus, the average pension fund underperformed a simple portfolio of index mutual funds.

The primary cause of the state pension’s poor investment performance

Thursday, January 30, 2014

A Suggestion for the new NCRS Investment Fiduciary Governance Commission


I applaud Treasurer Cowell in creating your committee and look forward to hearing your recommendations.  I wanted to share my thoughts.  I see no reason to start from scratch, but perhaps it might be best to essentially copy another state plan that seems to perform well with great transparency. 

The Minnesota State Retirement System (MSRS) and the Minnesota State Board of Investments (MSBI) could serve as a model for what North Carolina Retirement System should aspire to emulate.  Minnesota's pension is one of the largest in the country and has produced the best 3-year returns among state pension funds and second best for 10-year returns. NCRS pension returns have lagged behind the median pension significantly for these same periods and ranked 5th from last and 4th from last among states reporting for the 10-year and 3-year returns, respectively.

Not only has MSBI produced great returns, but they have also won awards for their excellent and timely financial reporting.  MSBI actually produces a Comprehensive Annual Financial Report (CAFR) that focuses ONLY on the state pension (North Carolina does not).  The MSBI CAFR actually includes real financial statements with detailed expense accounting and asset reporting (North Carolina does not).  The CAFR includes an audit opinion from the Minnesota Office of the Legislative Auditor.  MSBI has achieved all of this with an investment staff of just 22.

With an investment staff of 26, the NCRS poor relative investment performance compared to other state funds will not be solved by adding staff.  MSBI's good returns are due to a healthy 60% allocation to equities and less than 15% alternative investments (including real estate) and a focus on expense control (less than 30 bps of assets vs. NCRS over 50 bps).

The MSBI pension is slightly lower funded than North Carolina, but don't let that fool you.  It appears Minnesota employees only contribute 5% of their pay (up from just 4.25% a few years ago) and a full employer actuarial required contribution has not been made in the last 10 years. Meanwhile, NCRS participants contribute 6% (or more) of their pay to the pension, and our general assembly has been much better than Minnesota at making annual required actuarial contributions.  So, while MSBI is not as well "funded" as NCRS, I believe you will find it is much better "managed" and has better reporting transparency.

I urge the North Carolina Investment Fiduciary Governance Committee to read the MSBI CAFR and compare it to the North Carolina State Treasurer's Annual Report.  The treasurer's annual report includes information about the pension, but also other information that is irrelevant to the pension.  NCRS participants must read the treasurer's annual report, but also must know to look for and find the Government Investment Operations Report to find any expense reporting of the pension.  In addition, NCRS participants must know to look for the Investment Advisory Committee reports and minutes to discover more details on investments and actuarial data.  Finally, an NCRS participant must know they can find further pension details in the State of North Carolina CAFR.  This CAFR is some 300 pages and covers the ENTIRE state of North Carolina.  Of the 300 pages, only a handful pertain to the state pension and these pages are scattered throughout the 300 page document.  NCRS participants and North Carolina tax payers need a single CAFR dedicated to the pension plans that summarizes everything that is currently scattered haphazardly across several reports.  

Even after combining all the above-mentioned reports, you will find North Carolina's reporting woefully inadequate and returns alarmingly lower compared to Minnesota.  The MSBI CAFR also outlines how they structure their functional staff and oversight boards and committees.  The MSBI CAFR can be viewed by clicking here.

Also, South Dakota and North Dakota both have independent CPA firms that audit the retirement system CAFR each year (instead of another government entity). Additionally, while North Dakota's level of expenses and returns are nothing to brag about, their reporting is something to brag about as ND  publicly reports the investment performance of each and every external manager in addition to assets managed and fees paid.  Perhaps copying what works in Minnesota and adding a few tweaks to add more transparency like North and South Dakota could be a good place to start for your committee.

Thank you for your commitment to improving the NCRS pension fund.