A recent news release by the State Treasurers office reported that the $83 billion Teachers and State Employees Retirement System is outperforming its benchmark. The release claimed that the fund is solid and has successfully navigated the market turbulence of the past few years.
The fund is indeed solid, but this is because of the monthly contributions from state employees and teachers as well as the willingness of the current legislature to fund the system appropriately. It is in no way solid due to the expert management of the system.
The contention that the system is outperforming its benchmark is misleading. The system sets its own benchmark, so to beat it is meaningless.
There are two ways to look at a retirement system: how well is it funded (assets vs. liabilities) and how it is performing (how investments pay off compared with other systems).
Our system is well-funded because of the sacrifices made by state employees, teachers, retirees and the current legislature. Employees have continued to put 6 percent of their checks into the system each month even when the state put in nothing. Being well-funded because of the hard work and sacrifice of others is nothing about which the retirement system should crow.
What the retirement system should focus on is how its investment strategies and choices compare with its peers strategies and choices. The North Carolina retirement system is not meeting the benchmark of other public retirement funds, and that is an unpleasant reality.
We see the severe underperformance of our fund when we compare it with other states funds. For the year ending in June, the average state retirement fund returned 12 percent while North Carolinas earned 9.5 percent.
If our investment choices had resulted in just average performance, that wouldve translated into an additional $2 billion for our $83 billion system. The C students made at least 12 percent. We arent asking the sole person in charge of our investments to be a straight-A student, but its unacceptable that we arent even a C student. As of June 30, North Carolina was ranked 43 out of 47 states reporting returns an F in anyones gradebook.
To understand whether an investment manager has earned his or her keep, investors use benchmarks to measure performance. At the simplest level, a benchmark can be the S&P 500 or some other broad measure of the stock market. This is fine for a stock portfolio, but not appropriate for a more diversified portfolio that contains stocks, bonds and a host of other alternative asset classes.
For a portfolio such as this, the common approach is to create a custom benchmark that is a blend of the returns of a range of asset classes. For example, the North Carolina retirement system has benchmarks for global equities, fixed income, real estate, alternatives, credit and inflation. Each of these benchmarks is based on a formula using returns from these asset classes. These benchmarks are then combined to make an average Total Pension Plan benchmark.
In North Carolina, these benchmarks change from year to year and are made largely at the discretion of the retirement system itself. As the system gets to create its own benchmarks, it shouldnt come as a surprise that the fund often beats its benchmark.
The underperformance problems of the fund come from a variety of sources. First, the retirement system pays close to $400 million in Wall Street management fees each year. These fees dont account for all the underperformance, but they are not helping, and they certainly arent buying us stellar performance.
Second, the Treasurer has continued to increase alternative investments such as hedge funds, commodities and private equity. The performance of these asset classes has been mediocre, and they come with high costs and risks. Ultimately, though, the poor performance is largely due to poor investment decisions.
Digging out of this underperformance will take time, but one way to start is to benchmark it against a reasonable performance measure such as the average performance of U.S. state retirement funds. That way the retirement system will face long overdue scrutiny, and the Treasurers office will concentrate on improving the system rather than issuing self-congratulating news releases based on artificially low performance measures.
Ardis Watkins is legislative affairs director of the State Employees Association of North Carolina.