Sunday, October 23, 2016

Rejection of Index Investing at the Common Investment Meeting - This is Fraud.

So, the Comptroller has convinced the five city pension boards to attend a combined investment meeting, “Common Investment Meeting - CIM”, every month. Interestingly, the Teachers Retirement System continues to hold additional separate investment meetings every month.

The CIM is similar to a lecture hall class with 200 students as opposed to an ordinary class with 15 students. There is a certain circus quality to the meeting. You can judge for yourself. The videos are on this link.

I recently watched the September 26, 2016 meeting run by Scott Evans. He is the head of the Comptroller’s Bureau of Asset Management (BAM) and is paid $350,000 per year. The five pension funds actually pay his salary through a non-governmental grant scheme to the Comptroller’s revenue budget but the pension funds have no control over his hiring.

Comments on Index Investing

At about one hour into the show Mr. Evans started to comment on a possible simple index stock/bond investment strategy for the city's pension funds as opposed to the “sophisticated” strategy that the funds have adopted and he supports.

While he was not clear about what he precisely meant by the index stock/bond strategy, I am assuming that he was referring to the index stock-R-3000/core+5 bond strategy that NYCERS was using to a large extent circa 2000.

As of June 30, 2000, NYCERS had assets worth $43B of which $21B was in a Russell-3000 stock index and $10B was in a core+5 (Treasuries, investment grade corporate bonds and agency/mortgage backed bonds bond strategy, all with terms 5 years or greater) strategy. Together the two components were 75% of the total portfolio.

Specifically Mr. Evans stated that the index strategy would produce acceptable results, simplify the investment process for the pension funds, allow the pension funds to shrink the staff at BAM and have shorter investment meetings. He, however, claimed that it would be more risky than the “sophisticated” strategy and he made some vague reference to possible draw downs problems but nothing else.

That is basically the end of his discussion on this topic. He provided no quantitative support for his position. He felt his comment was sufficient to dismiss the index concept. No trustee asked any questions in spite of the importance and value of index investing.

What he failed to mention, however, was the actual historical rates of return for the two strategies. He did not list the radical differences in external fees, internal costs and taxes between the two strategies. He made no mention of the liquidity, volatility, currency, political, and credit risks inherent in the “sophisticated” strategy. He also failed to mention the potential of the “sophisticated” strategy for improper political influence and corruption which has occurred in the state pension fund in Albany and other public pension funds around the country.

Some Actual Numbers

In an effort to provide some specifics let me give you some historical numbers. Over the last 20 years (1996-2016) NYCERS assets have increased at annual rate of 3.4% per year, from $27.98B to $54.55B. See below.

From 1996 to 2000, as I mentioned above, NYCERS followed an investment strategy that was roughly 75% in a index/core+5 strategy with the other 25% in more dubious assets. The annual rate of increase in the assets for those four years was 11.3%. As of June 30, 2000 there were almost no private equity investments (non-publicly traded assets) in the NYCERS portfolio.

Since 2000, the annual rate of increase in NYCERS assets, using the quarterly numbers, has been 1.51%. Since 2007, that rate has been 2.88%. Needless to say, 2000 was the advent of the “sophisticated” investment strategy. By 2008 NYCERS was hip deep in shit with only 56% in the index/core+5 strategy. You can see that the trustees are not totally crazy.

Since 2009, NYCERS assets have increased at a 9.5% annual rate but the S&P 500 stock index has increased at an even higher 12.5% annual rate. As of June 30, 2106 NYCERS had assets of $54.6B. That number, however, includes a $3.2B positive cash inflow from 2009 to 2015 and $9.9B in non-publicly traded assets. The quoted values of non-publicly traded assets are basically guesses of what they are worth and you know the real number is less than $9.9B.

Based on the NYCERS official financial statements, which are different from the Comptroller's quarterly reports, the opening balance on July 1, 1999 was $41.9B and the closing balance on June 30, 2016 was $55.49B. That is an average annual increase of 2.53% for the seventeen years. The rate of increase for the S&P500 index/core+5 bond strategy with a 60/40 stock/bond allocation over the same 16 years is 4.648%. That translates into a $81.0B closing balance for June 30, 2016. That is a $25.5B higher than what NYCERS actually had. The sum of each year's difference individually is over $16.2B but compounded over the 16 years it is $25.5B. This is a big step towards full funding for NYCERS but we should be very aware that even indexing does not hit the 7% assumed interest rate that actuaries dream about.

Bottom line, NYCERS almost certainly would be in far better shape over any span of time with the “unsophisticated” index/core investment strategy. Of course, Scott Evans would be working somewhere else.

Listed below are the June 30 NYCERS asset values since 1985 as reported by the Comptroller in the quarterly performance reports along with closing balances from the CAFR's and estimates of index returns from FY-2000 forward.

  • Year - Quartely - CAFR CB - Indexing CB
  • 1985 - $10.178B
  • 1986 - $12.534B
  • 1987 - $13.866B
  • 1988 - $14.349B
  • 1989 - $16.499B
  • 1990 - $17.904B
  • 1991 - $18.852B
  • 1992 - $20.670B
  • 1993 - $22.939B
  • 1994 - $22.432B
  • 1995 - $25.455B
  • 1996 - $27.983B
  • 1997 - $32.439B
  • 1998 - $37.711B
  • 1999 - $41.024B
  • 2000 - $42.997B - $42.824B - $43.746B
  • 2001 - $37.519B - $37.251B - $40.222B
  • 2002 - $32.212B - $32.842B - $34.106B
  • 2003 - $30.841B - $31.524B - $32.477B
  • 2004 - $33,526B - $34.178B - $33.480B
  • 2005 - $34.703B - $35.526B - $35.406B
  • 2006 - $36.650B - $37.288B - $36.008B
  • 2007 - $42.237B - $42.514B - $42.707B
  • 2008 - $38.862B - $39.716B - $40.342B
  • 2009 - $30.929B - $31.903B - $34.490B
  • 2010 - $34.618B - $35.383B - $35.633B
  • 2011 - $41.623B - $42.409B - $42.107B
  • 2012 - $41,620B - $42.655B - $45.523B
  • 2013 - $46.623B - $47.194B - $47.862B
  • 2014 - $53.549B - $54.422B - $55.171B
  • 2015 - $54.289B - $54.889B - $57.106B
  • 2016 - $54.553B - $55.490B - $57.806B

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