Wednesday, March 16, 2011

The Cost of Bad Investment Decisions

For quite awhile I have been criticizing the NYCERS investment strategy as being overly risky and expensive. I have pointed out the radical growth in fees over the last eight years. I have not, however, given any specifics about how this risky strategy actually produces lower profits than a more conservative, less expensive strategy. So I recently ran a simulation of the NYCERS portfolio for the period from 2005 to 2010 using a conservative strategy.

Simply stated NYCERS uses a 70% stock/30% bond strategy. In addition, NYCERS has multiple variations within both of these classes. If, in 2005, NYCERS had returned to its traditional 50% stock/50% bond allocation and used only indexed stock funds and core bond classes, the simulation showed that NYCERS would have had a closing balance of $43B in FY-2010 instead of $35B. Listed below are the results of the simulation along with with the actual results since 2005.

*Closing BalanceProfit/LossClosing BalanceProfit/Loss

You will notice that the conservative strategy produced better results and smaller swings in the returns than the current aggressive approach. This is due to better profit/loss figures, higher dividend/interest payments, and lower investment fees. All of this creates a better operating environment for a mature pension plan that paid out $3.4B in benefits for FY-2010.

Another advantage of the conservative strategy is that it is totally liquid and based on published market values. The actual NYCERS closing balance for FY-2010 has a $3.5B component that is illiquid and not based on market values. This raises reliability issues about the actual value of this component.

To my knowledge the NYCERS investment advisor, Callan Associates, has never run this type of comparison simulation.

The fees for the conservative strategy would have been only $15M as opposed to the $175M that NYCERS actually paid in FY-2010. Of course there would have no lunches, dinners, golf outings, or campaign contributions with this strategy. There would also have been no temptation for possible bribes either.

The next time you hear someone attack public pension plans, point out to them that investment decisions by elected officials are the most immediate threat to the solvency of the pension plans.