NC Senate Bill 558 gives Wall Street a 42% raise, while state employees get nothing

     With all the hubbub about the North Carolina budget, how does our Treasurer have the gall to ask our legislature for a 42% budget increase?  I'm one of the few who have read and deciphered Senate Bill 558 and gone as far as to translate what it means in terms of expenses within the pension fund.  I wonder if Senate Bill 558 would pass if it had to go through the typical state budgeting process?

     Increasing the "alternative investments" allocation to 35% within the North Carolina Retirement System (NCRS) pension fund, will increase Wall Street fees paid by the pension fund by 42% or $160 million PER YEAR and that is exactly what Senate Bill 558 will do.  As NC State Finance Professor Richard Warr recently told the NC House Finance Committee, "there will be champagne toasts all over New York City" if Senate Bill 558 becomes law. 

     The following table shows the impact of Senate Bill 558 on investment expenses in North Carolina's pension fund:

     North Carolina's already high allocation to alternative assets are partly responsible for why 70% of all public pension fund returns beat our returns the past three years.  And, it's only getting worse as 83% beat our returns the past year (see page 38 in the May 29, 2013 Investment Advisory Committee presentation file by clicking here).  

     On page 37 of the presentation file above (see snapshot below), you will also find

North Carolina Retirement Systems Investment Expenses Are Out of Control

     Below is a summary of investment expenses incurred by North Carolina Retirement System's (NCRS) pension fund managed by our publicly elected Treasurer. The data are taken from the last annual Government Operations Report from June 30, 2012 provided by North Carolina's Department of State Treasurer.  

     I've calculated an Expense Ratio for each asset class provided in the "Gov Ops report" in much the same way a mutual fund would calculate an Expense Ratio.  I've also included long-term 10-year return information for each asset class where available as printed in the March 31, 2013 NCRS Quarterly Investment Update. 

  

     I'd like to point out that the State Legislature is currently mulling over Senate Bill 558 which would give the North Carolina State Treasure authority to invest up to 40% of the NCRS pension fund into Alternative Investments by primarily taking money out of the internally managed bond portfolio.  As can be seen in the table above, every dollar moved from the internally managed bond portfolio to Alternative Investments will incur expenses that are 178 times more expensive as the Internally Managed Bond portfolio.  That isn't a misprint.  Yes, the Alternative Investments portfolio expenses are 178 times MORE expensive than the Internally Managed Bond portfolio.   

How Underfunded is the North Carolina Retirement System Pension Fund?

     Recently Moody's Investor Services estimated North Carolina's pension fund is approximately $7.5 billion underfunded. North Carolina's Treasurer complained to Moody's as this might cause confusion since the North Carolina annual report shows an underfunding of only $3.7 billion.  The difference is the NC annual report must follow Governmental Accounting Standards Board (GASB) rules which result in horribly underestimated liabilities and overly optimistic future returns on assets.  The Moody's analysis, while still flawed is closer to reality.

     What is interesting is that both of these estimates are too low - and our Treasurer knows it. GASB plans to change their pension fund accounting standards from horribly ridiculous to merely ridiculous. Recently the Treasurer hired Buck Consultants to estimate how underfunded our pension fund will be when the new GASB standards take effect after June 30, 2014.  Buck Consultants found the State Employee and Teacher's portion of the plan will show to be $8.4 billion underfunded under then new GASB standards, and the Local Employee portion of the NC Retirement System will be underfunded by about $2.0 billion.  Thus, the entire NCRS would be underfunded by a whooping $10.4 billion under the new GASB pension fund accounting rules.  

     The full Buck Consultants analysis from 11/14/2012 can be found by clicking here.  Below are the two most relevant pages that show

Ben Graham and Warren Buffett both Advocate Index Investing

Perhaps shocking to some folks, but even the great Benjamin Graham (the father of value investing and Warren Buffett's mentor) became an advocate of indexing as the best investment strategy (click here to listen to this Jack Bogle speech at about the 55 minute mark).

Apple's Effective Federal Tax Rate is NOT 25% - it's likely less than 10%

Apple Computer was in the news recently as their CEO Tim Cook took some heat while testifying in front of Congress about the US Federal Corporate Income Tax.  The controversy around Apple revolves around how it is that Apple's "effective tax rate" is roughly just 25% when the US Federal Corporate Income Tax Rate is supposed to be 35%.  What I find shocking, is that Apple is able to get away with claiming they pay an "effective tax rate" of 25% when it is actually closer to 9.5%.

On pages 36-37 of Apple's 2012 Annual Report (SEC Form 10-K) the company states:

"The Company’s effective tax rates were approximately 25.2%, 24.2%, and 24.4% for 2012, 2011, and 2010, respectively. The Company’s effective rates for these periods differ from the statutory federal income tax rate of 35% due primarily to certain undistributed foreign earnings for which no U.S. taxes are provided because such earnings are intended to be indefinitely reinvested outside the U.S."

The second sentence above attempts to imply

The cook burnt your fries, so I gave you a few extra

     Janet Cowell, the State Treasurer of North Carolina has asked the state legislature for the authority to squander more of North Carolina Retirement System's Pension Fund money on so-called "Alternative Investments."  Cowell doesn't want just a little leeway, but wants to place a whooping 40% of the $80 Billion pension fund into these "Alternative Investments" or roughly $32 Billion (yes, that's Billion - with a capital B).

     Cowell's request reminds me of the fry cook who delivers your food and says, "I burnt your fries, so I gave you a few extra."  There is nothing worse than bad food - except, more of it.  Like a bad fry cook, Cowell wants to give North Carolina more of a bad investment.  And, our state legislature appears willing to give Cowell what she wants.  The proposal passed in the Senate yesterday, so it is up to the House to stop the insanity.

     "Alternative Investments" are essentially anything other than publicly traded stocks and bonds.  This includes real estate, private equity, hedge funds, and commodities just to name a few.  Alternative Investments tend to under-perform traditional stocks and bonds because the investment expenses are outrageously high (this is why Wall Street is so good at selling this trash).

     Take a look at the 10-year returns the various asset classes have earned within the North Carolina Pension Fund and you will easily see

The Retirement Gamble

If you have a 401(k) or IRA or any investments at all, click here for a must-see video "The Retirement Gamble" from last night's FRONTLINE on PBS.  The moral of the story:  When it comes to investing, expenses are your enemy, and index funds are your friends.

During the video, Jack Bogle, the founder of Vanguard and the inventor of the first low-cost index mutual fund, stated that over a lifetime many investors keep roughly one third (1/3) of their investment gains while Wall Street takes two thirds (2/3).  As shocking as it may seem, I wanted to reiterate that Jack Bogle's figures are correct.

Take the following example