North Carolina

Pension-Gate Continues: North Carolina is on Notice

North Carolina

Those of you who are long-time followers of ifa.com are probably aware of the attention we have given to the very large problem of mismanagement of public pension plan funds. Thanks to diligent research that has produced reports such as this one from the Maryland Public Policy Institute, we are able to draw a straight line between high fees paid to Wall Street and low returns received by the fund. The latest high-fee state to appear on our radar is the Tar Heel state of North Carolina, as discussed in this Forbes article by Edward “Ted” Siedle.

Mr. Siedle’s firm, Benchmark Financial Services, Inc. was retained by the State Employees Association of North Carolina (SEANC) to conduct a forensic accounting investigation to determine where all the money has gone. Indeed, there is quite a lot of it to follow--$416 million was paid in fees to Wall Street in the 2013 fiscal year, which represents a staggering additional $121 million over the prior year. Based on $80 billion of assets, the disclosed fees are 0.52%. However, since about one-third of the assets are internally managed bonds at a cost of 0.01 to 0.02%, the disclosed cost of the externally managed assets jumps to about 0.77%.

Please note the use of the term “disclosed”, as Benchmark uncovered asset and incentive fees paid to hedge fund managers contained within hedge funds of funds that were not disclosed by the state Treasurer. For one company alone, Franklin Street Advisers, the undisclosed fees were $10.4 million. But wait, there’s more! It turns out that the boys on Franklin Street don’t just run hedge funds, they also execute trades for them in an affiliated company, and wouldn’t you know it, they just happen to execute the trades for their own hedge funds at a healthy premium to what other brokers would charge.

The total asset management, incentive, and trading fees paid to Franklin Street were approximately $16 million and not the $2.6 million that was disclosed to the taxpayers. Seidle reaches a disturbing yet inescapable conclusion:

“As of this point in time, it is apparent that the fee information disclosed to the public and even the additional information disclosed to SEANC is incomplete and materially understates the state pension’s investment management fees and expenses…North Carolina workers deserve to know the full tab they are paying Wall Street billionaires for subpar investment performance. Once the magnitude of the fees being skimmed out of the pension is exposed, the resulting poor net performance will come as no surprise.”

Based on reported 4Q/2013 results, “poor” is not too strong of a word. The annualized return for the 15-year period (the longest shown) is 5.89%, which is the same as IFA’s Index Portfolio 35 (35% equities and 65% fixed income). The return of IFA’s Index Portfolio 60 (60% equities and 40% fixed income) over the same period was 7.72%. Considering that the returns of the IFA Index Portfolios are net of a 0.90% advisory fee, the comparison would look even worse for North Carolina if the IFA returns were adjusted for a lower advisory fee.

Unfortunately, the strategy over at the North Carolina Treasurer’s office is apparently to throw good money after bad, according to this Bloomberg article. The governor signed a bill last August that would raise the limit for alternative investments such as hedge funds of funds that returned -0.48% annually for the five years ending 6/30/2013, during which time the S&P 500 Index returned 7.05%.

We at Index Fund Advisors wish Mr. Seidle the best in his on-going investigation, and we hope that the other forty-nine states take notice, especially our own state of California.