One person, the State Treasurer, makes the investments for North Carolina’s $93.9 billion public pension. We are one of four states where a sole fiduciary has this responsibility. It is time to make a change and vest investment authority in a board of trustees.
Our new Treasurer, Dale Folwell, has come into office with a number of sensible ideas for improving performance and efficiency and cutting costs. However, in his first important set of decisions, Mr. Folwell has cost the pension far more than he has saved and provided compelling evidence that North Carolina needs to move investment authority from the State Treasurer to a board. In recent days, the state’s chief investment officer, Kevin SigRist, tendered his resignation. His departure reinforces the need to change the governance of the state pension plan in order to promote continuity.
Over the first six months of his tenure, Mr. Folwell has terminated 13 equity managers representing $7.3 billion in pension assets. Instead of reinvesting the proceeds in equities, the treasurer moved the money into fixed income and money market securities. This maneuver reduced the pension’s equity exposure well below its long-term target and represents one of the most elementary mistakes in investing: market timing. Clearly the treasurer is hoping the stock market will fall at some point and that he will be able to reinvest the proceeds at lower prices. Warren Buffet has called market timing a big mistake and commented on the maneuvers in his most recent annual letter:
“Ever-present naysayers may prosper by marketing their gloomy forecasts. But heaven help them if they act on the nonsense they peddle. Many companies, of course, will fall behind, and some will fail. Winnowing of that sort is a product of market dynamism. Moreover, the years ahead will occasionally deliver major market declines – even panics – that will affect virtually all stocks. No one can tell you when these traumas will occur – not me, not Charlie [Munger, Berkshire Hathaway’s president], not economists, not the media.”
And I’d add, not the state treasurer. The pension plan must earn 7.2 percent in order to avoid additional contributions from taxpayers or state employees. When the treasurer materially reduces equity exposure, which according to the Treasury Department’s own assumption should earn about 8 percent over long periods of time, Mr. Folwell is sacrificing hundreds of millions in future performance.
The treasurer has repeatedly publicized the $60 million in savings that he’s achieved so far by terminating and negotiating with equity managers. However, he has failed to account for the transactions costs that are being incurred to liquidate the equity portfolios, invest in bonds and money market instruments and eventually sell those positions so he can reinvest in stocks. In the end, the treasurer’s laudable objective of cutting management fees will cost the pension multiples of the fee savings. The pension cannot afford this kind of savings program.
In the coming months Mr. Folwell will tackle the far more complex issue of restructuring and reforming the pension’s hedge fund, real estate and private equity exposure, where the real performance, risk and fee issues reside. Over the last several years, the fees associated with these alternative investments have soared into the hundreds of millions of dollars. These asset classes deserve scrutiny, but any changes need to be done slowly and thoughtfully. Real estate and private equity can play a meaningful if modest role in the pension program. However, if the state treasurer does not act with care, he could produce more damage than good.
One person should not have the unfettered power to shift $93.9 billion in assets. I was the chief investment officer during Treasurer Richard Moore’s first term, and I appreciated the efficiency and decisiveness of advising a sole fiduciary. However, as the years have gone by, and the treasurer’s position has moved from Richard Moore to Janet Cowell and now Dale Folwell, I’ve seen the costs and risks in the pension rise as priorities change. Overall investment responsibility should not be limited to those who are tied to the election cycle. It’s time to vest a board with the job of investing the pension’s assets. Admittedly, a board of trustees is not a perfect form of governance. Boards have all sorts of potential idiosyncrasies and politics that can affect performance and risk management. However, a board provides the stability, continuity and institutional memory necessary to make sure that the pension’s investments aren’t jerked in one direction or the other every four to eight years.
Treasurer Folwell is a reformer. I hope he pursues the ultimate reform of the state’s public pension plan by relinquishing the power of the sole fiduciary in favor of an investment board.
Andrew Silton of Chapel Hill is a former chief investment officer of the North Carolina state pension fund. He writes the blog Meditation on Money Management.