Friday, April 12, 2013

The Basket Clause and the Real Pension Crisis

At the 3/26/2013 NYCERS investment meeting the trustees agreed to back the passage of legislation increasing the “basket clause” limit (Section 177 NYS RSSL)to 35% from 25%. The “basket clause” refers to the part of the investment portfolio that can be invested without any limitation. The limit was originally 5% but as the trustees have become more risk tolerant the limit has gone up to 25%. The trustees now want greater latitude in their decisions, hence the 35% limit.

This is a stupid and dangerous idea. Without a legitimate oversight of the trustees' investment decisions and performance the legislature in Albany should under no circumstance increase the trustees ability to make bad decisions. The trustees suffer no penalties for their mistakes, only the members, retirees, and the taxpayers of New York City get hit with the losses.

On their own public pension trustees are not capable of investing anything, period. You must always keep this in mind when evaluating the investment decisions that they make.

What the trustees are proposing is similar to a coach of basketball team that hits 10% of their 3-point shots and 50% of their 2-point shots trying to get his team to score more points. So he tells the team to shot more 3-point shots and less 2-point shots. Guess what. The coach gets fired because the team loses, but not the trustees. No one knows whether they are winning or losing.

To help them make their investment decisions, like hiring investment managers, the trustees hire investment consultants to provide objective advice. The consultants, however, get a significant amount of their profits from the investment managers. This arrangement is like a homeowner hiring a general contractor to do work on his house and allowing the subcontractors to pay the general contractor huge fees for being consider eligible to be awarded subcontracts. The homeowner winds up on the short end of the stick.

So how are the NYCERS trustees doing? Below is a score card for the last 13 years. For each year there are two closing balances using a 70/30 equity/fixed income allocation. One is the actual closing balance and the other is a simple S&P 500 index/ core bond index projection. You can click on Income Flow for a detailed spreadsheet. I suspected bad performance but I was amazed at how bad it really is.

In particular, why 2012 was so bad is a mystery to me. I have a bad feeling about it. The Comptroller is no longer providing investment meeting agendas on his web site.

NYCERS Investment Performance: 2000 - 2012

Year Closing Balance Closing Balance
**** NYCERS Index/Core Wins Losses
2000 $42.8B $44.20B **** $1,382M
2001 $37.3B $39.6B **** $2,364M
2002 $32.8B $34.1B **** $1,261M
2003 $31.5B $33.6B **** $2,056M
2004 $34.1B $39.1B **** $4,881M
2005 $35.5B $36.0B **** $ 510M
2006 $37.3B $37.0B $291M ****
2007 $42.5B $43.2B **** $ 641M
2008 $39.7B $39.4B $332M ****
2009 $31.9B $33.1B **** $1,174M
2010 $35.4B $35.7B **** $ 301M
2011 $42.4B $43.0B **** $ 546M
2012 $42.7B $45.3B **** $2,605M

If NYCERS had followed the straight index/core strategy since 2000, the closing balance for June 30, 2012 would have been $55.5B.

It is significant that in FY-2012 the NYCERS actuary formally reported a realistic liability for NYCERS at $62.94B.

From 2000 to 2006 the city and the participating employers systematically underfunded NYCERS hoping that future market increases would make up for the shortfall. That did not happen. The early funding decision has lead to increased current funding requirements. This is on top of the effect of poor investment decisions.

As a way of getting a feel for what is lost when annual funding for the pension plan is not adequate, the straight index/core closing balance as of 2012, with a steady small net cash delta, would have been $63.2B. That is a $7.8B increase due to the change in the net cash history.

Who is the main culprit in the city's pension dilemma?

A word of caution, I have a certain level of skepticism about the NYCERS investment accounting figures. In 2000, NYCERS reported only $13M in illiquid assets. BY 2013, the amount had risen to $6.25B. That is over 15% of the portfolio. Illiquid assets have no market values and any quoted value is just a guess.

Another point of aggravation is the fact that annual investment fees went from $30M to $130M over the 13 years.

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