How Do You Lose $174M in a Rising Market?

On October 31, 2016 the Comptroller's Office released the city's Comprehensive Annual Financial Report (CAFR) for FY-2016. This report, in particular, contains the basic financial information for the city's five pension funds.

Based on this report, NYCERS lost $174.2M in asset value during FY-2016 and had a closing balance of $55.59B. Even worse,during the same period the five city pension funds plus the TDA & VSF funds, in total, lost $1.323B in assets.

At a September NYCERS investment board meeting the Comptroller's representative, Scott Evans, presented a performance report to trustees that stated that the fund had earned a return of 1.76% for the year.

What he did not say was that NYCERS had lost $174.2M of assets during the year and obviously he did not explain how that had happened. In a year that the index/core rate of return was 3.9%, NYCERS assets fell by -0.32%.

This is absolutely unacceptable. In three of the last six years NYCERS lost assets. All six years were up markets. See the table below.

The Index/Core Performance for FY-2016

During FY-2016 the S&P500 Index increased in value from 2063.11 to 2098.86, a 1.7% increase for the year. Not good but above water.

The NYCERS bond core target was 7.16% for FY-2016. According to the September performance report NYCERS managed a 6.64% return in this asset class. That was C+ grade but not a loss of capital.

With a 60/40 stock asset allocation the fund should have produced a 3.904% increase in assets with a closing balance of $57.85B.

So how did NYCERS lose $174.2M in capital, a -0.32% loss?

Over the last 17 years NYCERS has managed to leave over $25B on the table because of investment decisions made by Comptrollers and trustees. There is no personal penalty for trustees if they fail to do their job. Hell, they don't even get fired. They just go to work for investment mangers.

NYCERS Investment Fees for FY-2016

NYCERS paid $212.9M in investment fees during FY-2016. That is 38 basis points on the closing balance of $55.59B. NYCERS should never pay more than 10 basis points in fees, even for beating the index/core strategy. 10 basis points is $55.6M, a savings of $157M.

Of course beating the index/core strategy is not possible for a pension fund over a long period of time. Investment returns over a long period of time always reverts to the mean, if you are lucky. Trying to beat the mean will cause a pension fund to fall short of average market returns over extended periods of time.

Six Year Review

Look at the last two rows in the table below. In only one year did NYCERS outperform the Index/Core rate of return. Just adding up the shortages for the six years listed below adds up to $4.2B. If you compounded the shortages for the six years, the loss is over $10B. When you compound the shortages over the last 17 years, the calculation produces a $25B loss.

Why do the trustees always make these bad decisions? Follow the money. Who is getting the extra $157M in fees. Who is making and receiving campaign contributions?

The following table is a recap of NYCERS income statements from FY-2011 to FY-2016:

Income Statement History

Year	FY-2016	FY-2015	FY-2014	FY-2013	FY-2012	FY-2011
Employee contributions	$485.5M	$467.1M	$447.7M	$437.8M	$403.6M	$413.7M
Employer contributions	$3.366B	$3.160B	$3.114B	$3.047B	$3.017B	$2.387B
Interest income(bonds)	$692.8M	$635.8M	$658.7M	$624.7M	$528.0M	$492.2M
Dividends(stocks)	$836.5M	$795.3M	$739.7M	$696.7M	$637.1M	$619.9M
Securities Lending	$29.7M	$26.5M	$8.8M	$27.8M	$25.0M	$23.4M
Income-In	$5.413B	$5.089B	$4.974B	$4.884B	$3.941B	$4.616B
Benefits/refunds	$4.403B	$4.236B	$3.990B	$3.851B	$3.689B	$3.569B
Transfers to the other pension funds	$7.4M	$7.1M	$7.2M	$5.3M	$5.0M	$4.4M
Skim to VSF's	-$41.2M	$41.9M	$202.1M	$12.3M	$12.4M	$12.4M
Investment Expenses	$213.0M	$231.8M	$184.6M	$183.3M	$129.5M	$145.1M
Administrative expenses	$56.7M	$54.6M	$50.4M	$48.7M	$51.4M	$46.4M
Income-Out	$4.638B	$4.571B	$4.283B	$4.101B	$3.888B	$3.770B
Net Income	$774.4M	$518.1M	$691.0M	$783.0M	$728.0M	$164.1M
Actual Cl. Bal.	$55.489B	$54.889B	$54.442B	$47.195B	$42.655B	$42.409B
Index/Core Cl.Bal.	$57.806B	$57.107B	$55.171B	$47.863B	$45.523B	$42.107B
Shortage	$2.317B	$2.217B	$0.749B	$0.668B	$2.868B	-$0.302B
Actual RR	-0.317%	-0.093%	13.850%	8.806%	-1.136%	19.391%
Index/Core RR	3.904%	3.981%	15.437%	10.373%	5.626%	18.537%

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

When You Buy a Ferrari and You Really Need a Pickup Truck

What happens when you buy a Ferrari, when you need a pickup truck?

You pay 10 times too much for what you need, you don't get what you need, and you pay a lot for mechanics. What you do get is a fast car.

It's too bad that the NYCERs doesn't even get a fast car when they make the wrong investment decisions.

Here's the the bill for the mechanics. And once again NYCERS is not even getting Ferrari mechanics.

As of August 2, 2015 the Comptroller increased the salaries of his investment staff. The story is that the five city pension funds were convinced to pay for the increases through their mindless subsidy to the Comptroller's budget. Of course, that is an illusion. It is the NYC taxpayers and the NYC employees who are paying for these increases. In fact, the employees pay twice, once as a taxpayer and a second time through their pension payroll deductions.

All the lucky people listed below are provisional employees. I wonder how permanent civil servants feel about that?

This is in addition to the five investment consultants that NYCERS paid $3.2M in FY-2014. Consultants are not the managers who do the actual investing but "experts" who advise the trustees on how oversee the managers.

Salary Increases at the Comptroller's Office

Count	Name	Civil Service Title	Assignment	% Increase	New Salary	Old salary	New Hire
1	Scott Evans	Pension Investment Advisor	CIO	56%	$350,000	$224,359
2	Michael Garland	Admin Staff Analyst	Corporate Governance	56%	$265,000	$169,872
3	John Merseburg	Admin Staff Analyst	Public Equities	93%	$250,000	$129,650	yes
4	Niel Messing	Admin Manager	Hedge Funds	67%	$250,000	$149,701
5	Alexis Done	Admin Staff Analyst	Private Equity	75%	$280,000	$160,000
6	Martin Gantz	Admin Staff Analyst	Fixed Income	62%	$280,000	$172,840
7	Yvonne Nelson	Admin Staff Analyst	Real Estate	69%	$265,000	$156,805
8	Petya Nikolova	Admin Staff Analyst	Infrastructure	59%	$250,000	$157,233
9	Miles Draycott	Admin Staff Analyst			$265,000
10	Evan Nahnsen	Admin Manager			$180,000
11	Noraina Pares	Admin Staff Analyst			$130,000
12	Tatiana Pohotsky	Admin Manager			$160,000
13	Wesley Pulisic	Admin Manager			$180,000
14	Steven Veloric	Admin Accountant			$160,000
15	Scott Zdrazil	Admin Manager			$170,000
16	Marc Gross	Admin Staff Analyst			$110,000	$70,833	yes
17	Vistoria Hui	Admin Staff Analyst			$120,000	$85,000	yes
18	Janet Londond-Valle	Admin Staff Analyst			$130,000
19	Karen Barclay	Admin Manager			$160,000
20	Shachi Bhatt	Admin Staff Analyst			$160,000
21	Yi Feng	Admin Manager			$180,000
22	Millicen Budhai-Robinson	Admin Staff Analyst			$110,000
23	Eneasz Kadziela	Admin Manager			$130,000
24	Lakhir Kaur	Admin Manager			$110,000	$70,000	yes
25	Louis Lent	Admin Accountant			$110,000
26	Barbara Nersten	Admin Accountant			$120,000	$70,789	yes
				Total =	$4,875,000