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.        

 

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%

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
			2000	2008	2016
			Harlan	Richard	Janet
			Boyles	Moore	Cowell
	Expense Ratio		0.1%	0.3%	0.7%
	Funding Ratio		113%	105%	96%
	S&P 500 Return*		21%	2%	15%
	Sources:	State Treasurer's Annual Reports
		Government Investment Operation Reports
		Investment Performance Reports
		Retirement Systems Valuation Report (10/15)
	*	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. 

Index Fund Returns Crush North Carolina Pension Returns (Again)

North Carolina Treasurer Janet Cowell recently released investment returns for the state pension fund.  The press release touted the returns as being slightly better than average over the past 5 years (45th percentile).  However, it is important to keep in mind that the NC pension fund fails to beat a simple mix of low-cost Vanguard index funds.

The table below shows the annualized returns of the NC pension fund compared to a simple portfolio of 5 Vanguard index mutual funds.

Annualized Investment Returns
as of 6/30/2016
	North	Vanguard
	Carolina	Index	Lost
	Pension	Funds*	Returns
1-Year	0.8%	5.4%	4.6%
3-Year	6.1%	8.0%	1.9%
5-Year	6.0%	9.1%	3.1%
7-Year	8.5%	11.2%	2.7%
10-Year	5.5%	7.3%	1.8%

*The Vanguard portfolio uses the same asset allocation the pension fund had when Harlan Boyles left office in 2000, before alternative investments were introduced to the portfolio. The analysis rebalanced the allocation of the Vanguard portfolio once per year.

Treasurer Cowell pointed out that the pension earned 8.5% annualized over the last 7 years - which approximates her tenure as North Carolina's Treasurer.  The simple Vanguard portfolio would have earned 11.2% over the same time period.  This difference of 2.7% per year for 7 years translates into $20 billion of lost returns during Treasurer Cowell's tenure.

For a state whose annual budget is $22 billion, the expansion of alternative investments in the pension fund from nearly zero to over 25% has been a silent fiscal catastrophe.    

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. 26^th 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

A Suggestion for the new NCRS Investment Fiduciary Governance Commission

To the North Carolina Retirement System (NCRS) Investment Fiduciary Governance Committee:

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.

Bravo! State Employee's Association of North Carolina Hires Pension Investigator

I applaud the State Employee's Association of North Carolina (SEANC) for hiring a pension and legal professional to investigate the North Carolina Retirement System (NCRS). You can read the SEANC press release by clicking here or the Charlotte Observer article by clicking here.  

Slowly but surely, more and more people are beginning to pay attention to one of North Carolina's greatest assets - the $83 Billion pot of money solely controlled by North Carolina's elected State Treasurer.  As the treasurer essentially reports to "the people," the treasurer in practice, reports to no one.  North Carolinian's probably don't realize the immense power the State Treasurer has as the sole-trustee of North Carolina's $83 Billion pension fund.  The sole-trustee set up is rare for this country as North Carolina is one of only 4 states with this structure.  No other elected politician in North Carolina controls this amount of money with virtually no checks and balances.     

While North Carolina has a very competent State Auditor in Beth Wood (a CPA), she has far too much on her plate to be able to give the attention required to fully understand the intricate web of details of a multi-billion dollar pension fund with increasingly complicated investments managed by over 200 external managers scattered globally.  And, does anyone really believe the State Legislature as a body is adequately monitoring the Treasurer's office?  

Great Op-Ed by SEANC regarding North Carolina Retirement System

Great Op-Ed in Raleigh's News and Observer by Ardis Watkins of the State Employees Association of North Carolina (SEANC):  
"The Truth About the Underperforming NC Retirement Fund"

It Appears the North Carolina State Treasurer is in Violation of G.S. 147-68

The North Carolina State Treasurer is required by law (G.S. 147-68) to make quarterly reports to the State Legislature.  These quarterly reports have always been posted to the Treasurer's website (click here and see the bottom of the page).  However, no reports have been posted since December of last year (2012).  It appears the Treasurer is fully three quarters behind in complying with the law, and will soon be a full year behind in her quarterly reports.

 These "Government Investment Operations Reports" (commonly referred to as the "Gov Ops Reports") are the only place investment expenses are ever reported for the North Carolina Retirement System (NCRS) pension fund.  Most notably, these reports include the amounts paid to external investment managers.  

These expenses are not even reported in the so-called "Annual Report" of the Treasurer - which is completely ridiculous.  If expenses are not reported in a Treasurer's Annual Report, why have the report at all?  There are plenty of happy pictures of the Treasurer and staff in the Annual Report, but not a single page that I would consider a "financial statement."  In the most recent Annual Report (18-month old data as of 6/30/2012), a single page (p. 100) contains one simple summary table which is the only list of expenses to be found in the entire report.  No details what so ever, just one summary table.  And, this lone table of expenses does not even include a comparison to last year's expenses.

MOST IMPORTANT, the one table of expenditures buried on page 100 of the Annual Report DOES NOT include ALL of the Treasurer's or NCRS departmental expenses.

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. 

North Carolina Pension Investment Performance is Bad, Again

North Carolina Treasurer Janet Cowell recently released North Carolina’s pension investment returns.  As usual, the press release did not provide any relevant point of reference as to whether the returns were “good” or “bad” other than to compare them to an obscure, undefined, and obviously cherry picked benchmark.  On the surface, it would appear the returns are “good” since every return for every time period was higher than this mysterious, ever changing, self-managed and self-serving “benchmark.”

I thought I’d compare North Carolina pension investment returns to the average public pension returns as published by The Bank of New York Mellon Public Pension Universe (click here and see page 4).  Glancing at the table below, I believe the word “bad” adequately describes North Carolina’s pension investment performance.  Over any time period one wishes to compare, the North Carolina pension investment performance lags the median public pension returns.

North Carolina Pension Investment Returns as of 9/30/2013
	1-Year		3-Year		5-Year		10-Year
North Carolina	9.97%		8.82%		7.78%		6.89%
Median Public Pension	12.25%		10.29%		8.23%		7.27%
Under-performance	-2.28%		-1.47%		-0.45%		-0.38%

Just to put the last year’s investment performance in perspective, if the $83 billion North Carolina pension merely had average returns, the pension would have earned an extra $2 billion. This is roughly the equivalent of 10% of the entire North Carolina state annual budget!  Or, this $2 billion short fall is roughly the equivalent of 20% of the entire state's annual spending on education. 

If you are a state employee or teacher and you are upset about budget cuts and a lack of raises, just imagine what the state of North Carolina could do with an extra $2 billion. That could be a reality if only your pension investments could achieve “average” returns.