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Bill Gives Treasurer Added Investment Flexibility
Publisher's note: The author of this post is Dan Way, who is an associate editor for the Carolina Journal, John Hood Publisher.
More pension funds could go into 'alternatives' some deem too risky
RALEIGH Supporters of a bill giving the state treasurer's office greater flexibility to invest money from the state's $81 billion pension plan affecting teachers, local government officials, police, firefighters, and judges cited a recent $1.5 billion loss to make their case.
Opponents said the change would lead to gambling with retirees' money in high-risk investments seeking large but often elusive payoffs.
Senate Bill 558, which narrowly avoided defeat in the House Finance Committee in a 14-13 vote, passed the House in two marathon debates, 61-51 on second reading and 67-43 on third reading. It passed the Senate by a 43-3 margin in the waning hours of the 2013 legislative session.
A last-minute amendment calling for a formal study of two issues was defeated. The first study would have looked into whether the current rule requiring the treasurer to earn an annual 7.25 percent return encourages riskier investment than a lower target. The second would have asked if principals other than the treasurer - who now has sole fiduciary responsibility - should oversee the retirement fund.
Though it drew bipartisan support, lawmakers feared the late addition could torpedo the bill.
"It is highly unlikely that there will be a studies bill, but as was the practice in the last session if this were something that the body wanted to do then the House would take the position that it would be commissioned through the [Legislative Research Commission]," said House Speaker Thom Tillis, R-Mecklenburg. "It's going to get studied one way or another."
The central debate was whether to give the treasurer more flexibility to move more money into potentially riskier investments instead of the current portfolio mix, primarily comprising bonds and blue-chip stocks that are considered safer risks. Treasures Janet Cowell and other supporters of added flexibility say that a broader range of investments could yield higher returns and reduce the taxpayers' obligation to pump money into the retirement fund.
The bill raises the cap on alternative investments in the following amounts: Debt and credit securities, from 5 percent to 7.5 percent; nonpublic and hedge funds, 6.5 to 8.5 percent; alternative investments (including private equity), 7.5 to 8.75 percent; and inflation protected investments (commodities and various bonds), 5 percent to 7.5 percent. Real estate remains at 10 percent.
The overall cap on alternative investments would climb from 34 percent of all investments to 35 percent.
"The risk of being very, very heavily invested in bonds is a very strong risk right now," said Rep. Jeff Collins, R-Nash, who works as a financial adviser and managed the conference committee report during final floor debates.
"Interest rates have been going down for the last 30 years. We've had a 30-year bull market in bonds. It's unprecedented in our nation's history," Collins said. But there are growing hints that interest rates are about to start rising, and "as interest rates go up, bond values go down."
That is why it is vital to have a more diversified portfolio and to allow the treasurer to be more nimble in reacting to market conditions, Collins said. And he echoed remarks Cowell made during House Finance Committee debate about the bond market.
"The bill came here on May 7, and in May and June while we were waiting for this bill to be heard we lost $1.5 billion in fixed income [investments]" due to market tremors over worries that interest rates were going up, Cowell said.
During debate on the conference report, Rep. Steve Ross, R-Alamance, a vice president and investment officer for Wells Fargo Advisors, emphasized that theme.
"If we have a 1 percent rise in the 30-year bond, that's a negative rate of return for that bond of 17.38 percent," Ross said. "If we get a 3 percent rise in the interest rates, that's a 52 percent decline in the value of those bonds. Multiply that times the number of bonds that are in the portfolio and we're talking about some serious money."
Cowell said the bill would enhance her ability to protect the investment portfolio, not jeopardize it. She noted that her Investment Advisory Committee unanimously backed the bill. She appoints that panel's members.
"We are still North Carolina. We are still a conservative state," she said. "I think there are a lot of caps, a lot of checks and balances."
Rep. Pat Hurley, R-Randolph, a state employee who has invested in the state retirement system for 20 years, cautioned House members to be mindful their vote affects 800,000 employees and retirees invested in the system. Those include the Teachers and State Employees Retirement System, Consolidated Judicial Retirement System, the Firemen's and Rescue Squad Worker's Pension Fund, the Local Governmental Employees Retirement System, Legislative Retirement System, National Guard Pension Fund, and the Retiree Health Benefit Fund.
"I mean no disrespect for the treasurer or her office," Hurley said, but she believes the bill is unnecessary and risky. She said the treasurer already has authority to invest up to 34 percent of the retirement fund in alternative asset classes but is investing only 22 percent in those categories.
Cowell said the goal is not always to meet the 34 percent overall cap, but to have more capacity in the subcategories to respond more easily to fluctuating market conditions.
For example, it would not make sense to max out capacity in an underperforming or money-losing subcategory, but it is smart policy to have higher capacity in the subcategories so when one is outperforming other classes more investments can be placed there to enhance the fund yield.
"We're rolling the dice literally like it were [Las] Vegas by putting money in those things," said Ardis Watkins, legislative affairs director for the State Employees Association of North Carolina. She said the retirement fund should stick to more traditional and less risky investments, especially given the treasurer's sole fiduciary authority over the $81 billion fund.
"One person is in charge of the amount of money that is four times what 170 of y'all [lawmakers] call the shots on over here in a $20 billion [General Fund] budget. That is a tremendous amount of power, and so what some people see as hamstringing by putting some checks and balances on that we think is only reasonable," Watkins said.
Richard Warr, professor of finance in the Poole College of Management at N.C. State who teaches advanced investments at the MBA and graduate level, said the alternative funds "are exorbitantly expensive" and "a complete lottery" whose risks "are horribly understated."
"If we managed the portfolio by a passive management method" by cutting out managers' fees and using index funds, "we could probably save $200 million," Warr said. "That's what 40 years of academic research supports.
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More pension funds could go into 'alternatives' some deem too risky
RALEIGH Supporters of a bill giving the state treasurer's office greater flexibility to invest money from the state's $81 billion pension plan affecting teachers, local government officials, police, firefighters, and judges cited a recent $1.5 billion loss to make their case.
Opponents said the change would lead to gambling with retirees' money in high-risk investments seeking large but often elusive payoffs.
Senate Bill 558, which narrowly avoided defeat in the House Finance Committee in a 14-13 vote, passed the House in two marathon debates, 61-51 on second reading and 67-43 on third reading. It passed the Senate by a 43-3 margin in the waning hours of the 2013 legislative session.
A last-minute amendment calling for a formal study of two issues was defeated. The first study would have looked into whether the current rule requiring the treasurer to earn an annual 7.25 percent return encourages riskier investment than a lower target. The second would have asked if principals other than the treasurer - who now has sole fiduciary responsibility - should oversee the retirement fund.
Though it drew bipartisan support, lawmakers feared the late addition could torpedo the bill.
"It is highly unlikely that there will be a studies bill, but as was the practice in the last session if this were something that the body wanted to do then the House would take the position that it would be commissioned through the [Legislative Research Commission]," said House Speaker Thom Tillis, R-Mecklenburg. "It's going to get studied one way or another."
The central debate was whether to give the treasurer more flexibility to move more money into potentially riskier investments instead of the current portfolio mix, primarily comprising bonds and blue-chip stocks that are considered safer risks. Treasures Janet Cowell and other supporters of added flexibility say that a broader range of investments could yield higher returns and reduce the taxpayers' obligation to pump money into the retirement fund.
The bill raises the cap on alternative investments in the following amounts: Debt and credit securities, from 5 percent to 7.5 percent; nonpublic and hedge funds, 6.5 to 8.5 percent; alternative investments (including private equity), 7.5 to 8.75 percent; and inflation protected investments (commodities and various bonds), 5 percent to 7.5 percent. Real estate remains at 10 percent.
The overall cap on alternative investments would climb from 34 percent of all investments to 35 percent.
"The risk of being very, very heavily invested in bonds is a very strong risk right now," said Rep. Jeff Collins, R-Nash, who works as a financial adviser and managed the conference committee report during final floor debates.
"Interest rates have been going down for the last 30 years. We've had a 30-year bull market in bonds. It's unprecedented in our nation's history," Collins said. But there are growing hints that interest rates are about to start rising, and "as interest rates go up, bond values go down."
That is why it is vital to have a more diversified portfolio and to allow the treasurer to be more nimble in reacting to market conditions, Collins said. And he echoed remarks Cowell made during House Finance Committee debate about the bond market.
"The bill came here on May 7, and in May and June while we were waiting for this bill to be heard we lost $1.5 billion in fixed income [investments]" due to market tremors over worries that interest rates were going up, Cowell said.
During debate on the conference report, Rep. Steve Ross, R-Alamance, a vice president and investment officer for Wells Fargo Advisors, emphasized that theme.
"If we have a 1 percent rise in the 30-year bond, that's a negative rate of return for that bond of 17.38 percent," Ross said. "If we get a 3 percent rise in the interest rates, that's a 52 percent decline in the value of those bonds. Multiply that times the number of bonds that are in the portfolio and we're talking about some serious money."
Cowell said the bill would enhance her ability to protect the investment portfolio, not jeopardize it. She noted that her Investment Advisory Committee unanimously backed the bill. She appoints that panel's members.
"We are still North Carolina. We are still a conservative state," she said. "I think there are a lot of caps, a lot of checks and balances."
Rep. Pat Hurley, R-Randolph, a state employee who has invested in the state retirement system for 20 years, cautioned House members to be mindful their vote affects 800,000 employees and retirees invested in the system. Those include the Teachers and State Employees Retirement System, Consolidated Judicial Retirement System, the Firemen's and Rescue Squad Worker's Pension Fund, the Local Governmental Employees Retirement System, Legislative Retirement System, National Guard Pension Fund, and the Retiree Health Benefit Fund.
"I mean no disrespect for the treasurer or her office," Hurley said, but she believes the bill is unnecessary and risky. She said the treasurer already has authority to invest up to 34 percent of the retirement fund in alternative asset classes but is investing only 22 percent in those categories.
Cowell said the goal is not always to meet the 34 percent overall cap, but to have more capacity in the subcategories to respond more easily to fluctuating market conditions.
For example, it would not make sense to max out capacity in an underperforming or money-losing subcategory, but it is smart policy to have higher capacity in the subcategories so when one is outperforming other classes more investments can be placed there to enhance the fund yield.
"We're rolling the dice literally like it were [Las] Vegas by putting money in those things," said Ardis Watkins, legislative affairs director for the State Employees Association of North Carolina. She said the retirement fund should stick to more traditional and less risky investments, especially given the treasurer's sole fiduciary authority over the $81 billion fund.
"One person is in charge of the amount of money that is four times what 170 of y'all [lawmakers] call the shots on over here in a $20 billion [General Fund] budget. That is a tremendous amount of power, and so what some people see as hamstringing by putting some checks and balances on that we think is only reasonable," Watkins said.
Richard Warr, professor of finance in the Poole College of Management at N.C. State who teaches advanced investments at the MBA and graduate level, said the alternative funds "are exorbitantly expensive" and "a complete lottery" whose risks "are horribly understated."
"If we managed the portfolio by a passive management method" by cutting out managers' fees and using index funds, "we could probably save $200 million," Warr said. "That's what 40 years of academic research supports.
| Governor McCrory Clears the Way for Rural Center Grants | Statewide, Government, State and Federal | Beaufort County Takes Another Step Toward Early Revaluation |
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