- Global Equity (publicly traded stocks)
- Fixed Income (publicly traded bonds)
- Real Estate (partnerships that buy shopping malls and office buildings)
- Alternatives (private equity, venture capital, hedge funds)
- Credit (junk bonds and bank loans)
- Inflation (derivative securities on commodities: eg. futures and options on gold or corn, etc.)
Most folks are familiar with the first two categories which are just traditional stocks and bonds. But, the next four categories might come as a surprise to some pensioners to discover their retirement is being bet on such items as private equity, hedge funds, junk bonds, and derivatives. The worst part of the surprise is that the four new categories have all produced returns lower than a simple, traditional, 60% / 40% mix of stocks and bonds.
NCRS 10-year returns
Stocks = 8.0%
Bonds = 6.8%
60/40 Stock/Bond = 7.5%
Alternatives = 5.3%
Real Estate = 3.8%
Over the past 10 years, the North Carolina Retirement System has piled money into Real Estate and Alternative Investments (hedge funds, private equity, venture capital) in an effort to "diversify" the investment portfolio away from stocks and bonds. It takes some mathematical gymnastics I won't bore you with, but my best estimate is that the Real Estate and Alternatives asset classes have cost the state of North Carolina about $3 billion in lost earnings relative to the plain vanilla stocks and bonds from which the money was pulled.
Now the NCRS is compounding their previous mistake by once again creating two new asset classes in which to squander pensioner money. While we only have one year of performance figures for the two newest asset classes, they have already significantly underperformed a simple 60/40 split of stocks and bonds.
NCRS 1-year returns
Stocks = 22.4%
Bonds = 8.7%
60/40 Stock/Bond = 16.9%
Credit = 8.7%
NCRS 10-year returns
Stocks = 8.0%
Bonds = 6.8%
60/40 Stock/Bond = 7.5%
Alternatives = 5.3%
Real Estate = 3.8%
Over the past 10 years, the North Carolina Retirement System has piled money into Real Estate and Alternative Investments (hedge funds, private equity, venture capital) in an effort to "diversify" the investment portfolio away from stocks and bonds. It takes some mathematical gymnastics I won't bore you with, but my best estimate is that the Real Estate and Alternatives asset classes have cost the state of North Carolina about $3 billion in lost earnings relative to the plain vanilla stocks and bonds from which the money was pulled.
Now the NCRS is compounding their previous mistake by once again creating two new asset classes in which to squander pensioner money. While we only have one year of performance figures for the two newest asset classes, they have already significantly underperformed a simple 60/40 split of stocks and bonds.
NCRS 1-year returns
Stocks = 22.4%
Bonds = 8.7%
60/40 Stock/Bond = 16.9%
Credit = 8.7%
Inflation = 4.8%
History doesn't repeat itself, but it sure does rhyme sometimes. The lesson here is that sometimes doing less, is more. We've seen that had the North Carolina Retirement System stuck with its simple stock and bond portfolios the pension fund would have been significantly better off now. I suspect the same will be true in the next 10 years as well.
The NCRS currently has about $3 Billion invested in the "Credit" portfolio (junk bonds and bank loans). Since the "Credit" portfolio returned just 8.7% so far, and the fund could have left the money in its previous 60/40 stock/bond split that returned a much higher 16.9%, we can estimate that this move into junk bonds has cost the state of North Carolina roughly $250 Million in foregone returns just in its first year.
Likewise, the NCRS currently has about $2.5 Billion in the "Inflation" portfolio (commodity derivatives). Since the "Inflation" portfolio returned just 4.8% so far, and the fund could have left the money in its previous 60/40 stock/bond split that returned a much higher 16.9%, we can estimate that this gamble on commodity derivatives has cost the state of North Carolina roughly $290 Million in foregone returns just in its first year.
Thus, the two new asset classes that our State Treasurer invented last year has cost North Carolina roughly half a billion dollars - so far. "Worsification" in the name of diversification. Unfortunately, the problem is only going to get bigger as our State Treasurer is in the process of moving another $3 Billion out of stocks and bonds and into the so-called Alternatives, Credit, and Inflation asset classes.
I'm sure our State Treasurer would defend the moves by claiming they may have lowered the risk of the pension fund based on the most narrow statistical definition of risk. However, our pensioners cannot eat these risk-adjusted returns. The bottom line is, North Carolina's tax payers will have to pay for our State Treasurer's blunders.
History doesn't repeat itself, but it sure does rhyme sometimes. The lesson here is that sometimes doing less, is more. We've seen that had the North Carolina Retirement System stuck with its simple stock and bond portfolios the pension fund would have been significantly better off now. I suspect the same will be true in the next 10 years as well.
The NCRS currently has about $3 Billion invested in the "Credit" portfolio (junk bonds and bank loans). Since the "Credit" portfolio returned just 8.7% so far, and the fund could have left the money in its previous 60/40 stock/bond split that returned a much higher 16.9%, we can estimate that this move into junk bonds has cost the state of North Carolina roughly $250 Million in foregone returns just in its first year.
Likewise, the NCRS currently has about $2.5 Billion in the "Inflation" portfolio (commodity derivatives). Since the "Inflation" portfolio returned just 4.8% so far, and the fund could have left the money in its previous 60/40 stock/bond split that returned a much higher 16.9%, we can estimate that this gamble on commodity derivatives has cost the state of North Carolina roughly $290 Million in foregone returns just in its first year.
Thus, the two new asset classes that our State Treasurer invented last year has cost North Carolina roughly half a billion dollars - so far. "Worsification" in the name of diversification. Unfortunately, the problem is only going to get bigger as our State Treasurer is in the process of moving another $3 Billion out of stocks and bonds and into the so-called Alternatives, Credit, and Inflation asset classes.
I'm sure our State Treasurer would defend the moves by claiming they may have lowered the risk of the pension fund based on the most narrow statistical definition of risk. However, our pensioners cannot eat these risk-adjusted returns. The bottom line is, North Carolina's tax payers will have to pay for our State Treasurer's blunders.
Dear Sir,
ReplyDeleteyou simplify matters. First you judge the performance in hindsight. It is always easy to judge an event after it has happened.
Second, you assume that the pension fund cares only about the first moment. Including more asset classes that are fundamentally driven by other risk factors increases the risk characteristics of a portfolio. This is the case here. What the fund is doing is smoothing it's returns over different market cycles. This is quite sensible, considering that it needs to match liabilities which are mainly driven by the term structure of interest rates. The more risk factors you add that are not highly correlated with the Term Structure, the better the risk adjusted performance of the liability matching portfolio is going to be.
Yours sincerely
Alexander