Apr 10, 2017

North Carolina's financial fee folly

SZfarmer/Wikicommons

Dale Folwell is North Carolina's new state treasurer, having been elected after a campaign in which he railed against fees being charged by Wall Street money managers. He's also the hero in a new profile from Bloomberg Businessweek, which slobbers over his pledge to save the state retirement system "a minimum of $100 million a year in fees by the end of his four-year term."Bottom line: Fees can indeed be problematic but, in North Carolina, most of the fees are actually tied to strong investment returns. Folwell doesn't seem to connect those dots.Let's dig in:Fee data: North Carolina's $90 billion state retirement system last year paid $513 million in management and incentive fees to outside money managers. Of that, $288 million went to real estate ($196m) and private equity managers ($92m). The system also paid out another $90 million in adminstrative expenses, some of which includes outside investment consultants.That pledge: The $100 million in savings is cumulative over four years (which is different than what Bloomberg reported), per an investment committee meeting note and confirmation from a Treasurer's Office spokesman. Given that Folwell already has saved $17 million per year by dumping four public equities managers, that means he really only has to find $8 million in additional annual savings. This could be done by cutting more active stock managers, or perhaps a secondary sale of private equity interests (which NC has asked Houlihan Lokey to explore). Folwell also has broached renegotiating fee agreements with hundreds of existing fund managers, but to no avail.Performance: The two asset classes that comprise the bulk of fees ― real estate and private equity ― also are the system's two best performing asset classes (net of fees) over both a three-year and five-year period.Folwell to Bloomberg: "We don't own alternative investments. They own us... I think they increase complexity and reduce value."Huh? North Carolina's public pensioners are clearly getting the most bang for their bucks from alternatives (again, net of fees), but their Treasurer says that such investments "reduce value." Moreover, Folwell confirmed to Axios during a Friday interview that has put an indefinite freeze on new investment commitments to alternative funds. When asked if he's concerned that pensioners will consequently lose out on participating in new funds from existing managers like New Enterprise Associates and HgCapital, Folwell said that he hadn't heard of either firm.Reconciliation: The trouble here is that Folwell isn't connecting the dots between fees and performance, where applicable. He also is mentally merging the 'active vs. passive' argument in public equities with the issue of alternatives fees. To be sure, limited partners in alternatives must be vigilent over fees, particularly given some of the shenanigans that have been uncovered in recent years.But when Axios repeatedly asked Folwell if he'd be willing to pay high fees in exchange for outsized performance ― thus creating a net positive for pensioners ― he effectively changed the subject, adding that he'd only been on the job for a couple of months. That simply doesn't cut it, no matter how well-intentioned Folwell appears to be. The new Treasurer had an entire campaign and transition period to examine the data, and several months now to speak with in-house investment staff. If he believes alternatives are going to falter in the long-term, then make that case. But hewing to campaign promises about cutting fees, regardless of performance, is not serving as a proper fiduciary to North Carolina pensioners.

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