North Carolina Retirement System Pension Fund Should Index

Last week I blogged about how bad North Carolina's pension investment returns have been.  This week, I thought I'd point out a simple solution to the poor performance.  A simple portfolio of Vanguard Index Mutual Funds not only would beat the performance of North Carolina's pension, but has outperformed more than 75% of all public pensions over the past 3, 5, and 10 year periods. (Click here and see page 4 for investment returns of all public pensions). 

	North Carolina Pension Investment Returns as of 9/30/2013
		1-Year		3-Year		5-Year		10-Year
	North Carolina Pension	9.97%		8.82%		7.78%		6.89%
	Median Public Pension	12.25%		10.29%		8.23%		7.27%
	Passive Index Mutual Funds*	12.33%		12.00%		10.33%		8.42%
	NC Under-performance vs. Index Funds	-2.36%		-3.18%		-2.55%		-1.53%
	NC Tax-payer cost for under-performance	$2	Billion	$8	Billion	$11	Billion	$13	Billion

Why all pensions don't index is a mystery to me?  North Carolina’s pension at $83 billion, like many public pensions, are so large, it's inconceivable that their 240+ external managers could collectively outperform "the market."  It is ridiculous – and expensive – for them to even try. 

How expensive?  While North Carolina’s 240 external managers are paid roughly $300-400 million each year(and growing rapidly, click here and see page 8), North Carolina’s underperformance versus a simple portfolio of index mutual funds has cost tax payers roughly $13 Billion over the past 10 years*.  Stated another way, the North Carolina pension could have been $13 billion bigger had they never taken money away from stocks and bonds only to squander it on expensive, poor performing alternative investments such as hedge funds, private equity funds, real estate, and especially commodities.

The majority of this underperformance and cost has been due to particularly poor performance the past 5 years as North Carolina Treasurer Janet Cowell has increased the fund's allocation to so-called alternative investments in the name of "diversification" from 10% to 20% with an ultimate goal of 35%.  As the above performance figures clearly show, North Carolina’s performance has continued to get worse and worse relative to other pension funds and simple index funds over time. 

*  NOTE: The simple portfolio of Vanguard Index Mutual Funds that beat North Carolina and more than 75% of all pension funds, is from page 32 of my book “TheRollover IRA Cookbook.”  The returns above have been calculated using Morningstar’s portfolio scenario tools with semi-annual re-balancing. The portfolio of 65% stock mutual funds and 35% bond mutual funds approximates a similar asset allocation and risk profile as the North Carolina pension fund which is currently allocated 68% to stocks and alternatives and 32% to bonds.  NC tax payer costs were estimated using a simple time-value of money financial calculator.