Monday, February 5, 2018

Tax Cuts & Jobs Act creates winners and losers

The Tax Cuts And Jobs Act has created winners and losers - sometimes on the same team.  Take Sally Beauty Holdings (ticker: SBH).  This is a company whose 35% federal tax rate should fall to 21% under the new law.  This should boost SBH after-tax profits by roughly 22% or $48 million.  Since stocks are priced based on profits, it stands to reason the SBH stock should rise and handsomely benefit executive management that are rewarded with stock and stock options.

However, much of SBH’s rural sales reps will be on the losing side of the new tax law.  A typical SBH traveling sales rep might earn $60,000 per year, but could incur $20,000 in unreimbursed business travel expenses.  Thus, this rep really only earns $40,000 per year. 

Under the old tax code, the typical rural SBH sales rep could deduct the $20,000 of unreimbursed business travel expenses (stuff like 25,000 miles on their personal car and hotel and meals away from home) as a Miscellaneous Itemized Deduction on Schedule A via Form 2106 for Unreimbursed Employee Business Expenses.  So, the SBH rep that really only netted $40,000 from their job, only paid taxes on the $40,000.

However, the new tax law completely eliminated all Miscellaneous Itemized Deductions on Schedule A.  Now the SBH rep has to pay income taxes like they earned $60,000 even though they spent $20,000 to earn that paycheck.  This will result in roughly $4,000-$5,000 in higher taxes for the SBH traveling sales rep.

So, under the old tax law, the SBH sales rep that makes $60,000 in W-2 wages had a real net pay of $40,000, less $4,000 federal tax, less $4,500 in payroll taxes might have had $31,500 in spendable income.  Under the new tax law, that spendable income may fall 13-16% to around $28,000. 

Sunday, November 26, 2017

NCRS Pension and Treasurer Folwell

Bottom line: NC Treasurer Dale Folwell is headed in the right direction. But, progress is never a straight line.

Treasurer Folwell impressed me by freezing new commitments to alternative investments.  He further impressed me by quickly firing a dozen active equity managers. But, I was disappointed that the $7 Billion of equities was liquidated instead of being transferred to index managers.  This lowered the equity exposure of the pension portfolio from 44% to 37% at a time that equities rose 10-15%. 

However, to be fair, the self-described longterm target allocation to equities is 42% for the NC pension.  Thus, liquidating some of the fired manager portfolios made sense as the fund was essentially 2% over-weight equities. And, the current allocation of 38% is well within the self-imposed guidelines of the fund of 37-47% equities.  

Treasurer Folwell will likely face criticism from the investment industry for his strategy of moving away from trendy, expensive alternative investments and toward low-cost inhouse indexing.  (A strategy I fully support!) Thus, the treasurer can’t really afford the distraction of further criticism for straying from longterm asset allocation targets. 

Hopefully Treasurer Folwell will ignore the barking from Monday-morning quarterbacks, continue to resist pressure to make new investments, and resume his intense focus on cutting manager fees by moving toward low-cost, inhouse passive managent of plain vanilla stocks and bonds.  

Sunday, April 2, 2017

Picking Stocks is Hard, Picking Mutual Funds is Harder

Princeton Economist Burton Malkiel, author of "A Random Walk Down Wall Street" famously pointed out, 
“If picking stocks is a random walk down Wall Street, picking mutual funds is an obstacle course through Hell’s Kitchen."
The editors of Kiplinger's personal finance magazine have validated that statement.  Kiplinger's regularly publish "The Kiplinger 25" - a list of Kiplinger's favorite mutual funds.  I dug up a 10-year-old Kiplinger's magazine from January 2007 and analyzed the 10-year-old Kiplinger 25 with the help of Morningstar. Here's what I discovered:
  • Only one mutual fund from the January 2007 Kiplinger 25 still makes the Kiplinger 25 just 10 years later.  I won't even tempt you with the name of that one surviving fund since it has under-performed it's style benchmark index by more than 1% per year the past 10 years.  
  • 17 of the Kiplinger 25 funds have failed to beat their style benchmark index the past 10 years. 
  • The average Kiplinger 25 mutual fund under-performed its style benchmark index by an average of 1.25% per year the past 10 years. 
  • The average US stock fund in the Kiplinger 25 under-performed its style benchmark by an average of 2.10% per year the past 10 years. 

Thursday, October 20, 2016

Nevada Does Not Gamble With Their Public Pension

The Wall Street Journal recently ran an article about the Nevada Public Employee Retirement System pension investments.  The entire pension investments are managed by one single person who invests 100% in passive index funds.  The entire investment process costs a paltry $18 million per year.  Compare that to North Carolina's annual costs of $595 million per year (see page 10).

Now compare the investment results ending June 30, 2016:

          NV           NC
1-year 2.3% 0.8%
3-year 7.8% 6.1%
5-year 7.7% 6.0%
10-year 6.2% 5.5%

Click here to view the actual investment return reports for Nevada and North Carolina.

Now consider this, the difference between 7.7% and 6.0% returns amounts to $10 Billion in lower returns over just the past 5 years for North Carolina's $90 Billion pension fund.  That $10 Billion shortfall will need to be made up by North Carolina tax payers and lower payouts to retirees.  The result is, taxes will need to be higher and less money will be available for services such as education and healthcare. Considering North Carolina's entire state budget is just $22 Billion each year, the $10 Billion in lower pension returns is a silent fiscal catastrophe the burden of which will be felt for generations.

It is brutally clear, that the North Carolina pension should aim to emulate Nevada.  North Carolina needs to quit investing in expensive investment strategies that do not work.  North Carolina needs to follow Nevada's example and invest 100% in passive indexed strategies and quit squandering money on private equity, real estate, hedge funds, commodity funds, and other expensive actively managed investments.        


Wednesday, September 7, 2016

42 Years of NC Pension Investment Returns

There has been a lot of hand wringing over the North Carolina Retirement System Pension Fund investment returns - as well there should be.  As I've documented previously on this blog, the returns could have been substantially higher had Richard Moore and Janet Cowell not squandered billions on a failed foray into alternative investments.

In Treasurer Cowell's most recent investment performance report, the pension earned an annualized return of just 5.8% per year over the last 15 years ending 6/30/2016.  This return is far below the actuarial assumed rate of return of 7.25%.  These figures have led some to question if the 7.25% return is attainable long term and should it be lowered?  I honestly do not know the answer to that question, but for what it is worth, I made a trip to the State Library and collected 42 years of NC pension investment returns from old, dusty annual reports from the Department of State Treasurer.

I calculated a geometrically-linked annualized return for the 40 years that came to 7.9% for the NC pension fund.  As a point of reference the S&P 500 Index return was 11.0% while the Barclays/Lehman Aggregate Bond Index return was 7.7% for the same 40 year period ending 6/30/2016.

While interesting, I'm not sure how helpful these return data are.  In the 70's and into the 80's more than 85% of the pension was invested in investment grade bonds with less than 15% allocated to stocks.  By 2000, the fund was invested 60% in stocks and 40% in bonds.  Today, 28% of the fund is invested in neither stocks or bonds, but in other "alternative" investments.  Thus, history is not particularly helpful for predicting future returns.

Something else I discovered in the old annual reports, as recently as the early 80's the actuarial assumed rate of return was just 6%.  At some point it was raised and we now assume 7.25%.  Of course the problem with any assumption is that inflation was double digits in the 70's and near zero more recently.  Thus, picking an "absolute" assumed rate of return for a pension fund with an infinite time horizon is a fools game from the start.  Almost every economic study begins by adjusting figures for inflation.  It might be helpful for actuaries to try to incorporate some sort of assumed return over and above inflation, instead of changing the absolute return assumption every 20 years?

For what it is worth, here are the 42 years of return data I found:

NCRS Pension Returns
as of 6/30/2016
Time Annualized
Period Return
1-Year 0.8%
5-Year 6.0%
10-Year 5.5%
15-Year 5.8%
20-Year 6.6%
25-Year 7.0%
30-Year 7.5%
35-Year 7.9%
40-Year 7.9%
42-Year 7.8%

NC Pension Returns
years ending 6/30
Year              Return
2016 0.80%
2015 2.25%
2014 15.88%
2013 9.52%
2012 2.21%
2011 18.48%
2010 11.97%
2009 -14.22%
2008 -2.07%
2007 14.82%
2006 7.23%
2005 9.85%
2004 12.01%
2003 7.56%
2002               -4.04%
2001 -2.0%
2000 9.0%
1999 10.7%
1998 19.4%
1997 8.9%
1996 9.5%
1995 8.3%
1994 8.5%
1993 9.0%
1992 8.8%
1991 8.8%
1990 9.1%
1989 9.3%
1988 11.5%
1987 10.6%
1986 11.2%
1985 10.4%
1984 9.9%
1983 10.6%
1982 9.7%
1981 8.8%
1980 8.1%
1979 7.6%
1978 7.1%
1977 6.9%
1976 6.8%
1975 6.6%

Wednesday, August 24, 2016

North Carolina Pension Fund Sure Misses Harlan Boyles

Last week North Carolina State Treasurer Janet Cowell posted the Government Investment Operations Report for the North Carolina Retirement System Pension Fund for the fiscal year ending June 30, 2016.  The report says the treasurer spent $595 Million managing the $87 Billion pension fund investment portfolio.  That's up from just $57 Million when the pension was $59 Billion when Harlan Boyles retired in 2000.

NC Retirement System Pension Fund
Expense Ratio
Funding Ratio
S&P 500 Return*
7-year Annualized Return

While the pension fund assets have increased 47% since Harlan Boyles retired, the expenses incurred managing the investments have increased an astonishing 1,044% while the funding ratio has fallen 17 points.  This irresponsible explosion of investment expenses is a boon for Wall Street, but a silent fiscal catastrophe for North Carolina, the burden of which will be borne by the pensioners and taxpayers for years to come.