If you had $90 billion to invest, how would you do it? For Dale Folwell, it’s a serious question. As the newly elected treasurer of North Carolina, he’s by law the one person who gets to decide how to manage the state pension fund for government employees, the world’s 26th-largest pool of public money.
Folwell, 58, became the state’s first Republican treasurer in 140 years partly on the strength of a simple investment strategy he proposed: Instead of paying money managers big fees, the state should use a slim menu of cheap, mostly indexed investments and manage them in-house when possible.
The state paid $600 million in outside managers’ fees, incentives, and related costs last year, seven times more for every dollar under management than it paid in 2000. Folwell envisions saving the fund a minimum of $100 million a year in fees by the end of his four-year term.
“It’s not emotional. It’s not political. It’s mathematical,” says Folwell, a certified public accountant and former state legislator—who’s also been a mechanic and a national dirt-bike racing champ. His calculation is simple: Expenses come right off the top of returns, and money managers as a group struggle to beat the market after their fees. For example, in the decade through June 30, 2016, about 85 percent of large-cap U.S. stock funds trailed the S&P 500 index, according to S&P Dow Jones Indices.
Folwell has already unloaded six actively managed stock funds that controlled $3 billion for the state and charged combined fees of $17 million in the fiscal year through last June. But a wide-scale firing of Wall Street won’t be easy, he says, because his two most recent predecessors signed long-term contracts with some private equity and hedge funds. Such investments are often called alternatives. Funds operated by Blackstone Group LP, Warburg Pincus, and Starwood Capital Group are among those listed in the pension system’s holdings.
“We don’t own alternative investments. They own us,” Folwell says. “I think they increase complexity and reduce value.” Folwell’s most recent predecessor, Janet Cowell, declined to comment. The treasurer who came before her, Richard Moore, didn’t respond to requests for comment.
One might think a public fund with billions of dollars to put to work would have some leverage to negotiate a discount. Not so simple, Folwell says. Money managers he talks to keep citing most-favored-nation clauses in their contracts that say they can’t offer a break to one client without providing the same break to others. Even if he wasn’t stuck in long-term contracts, it might be difficult to unload huge stakes quickly without needlessly incurring fire-sale losses, because the funds tend to hold illiquid assets.
In the election, Folwell won the endorsement of the State Employees Association of North Carolina, which represents 55,000 public employees. “He doesn’t carry water for his party,” says Ardis Watkins, a lobbyist for the group. It had fought the plunge into costly investments and advocated making the terms of the deals with managers public.
In February, Warren Buffett gave a boost to Folwell’s argument. The longtime Berkshire Hathaway Inc. boss wrote in his annual shareholder letter that pension funds and other supposedly savvy investors had wasted $100 billion over the past decade on high-priced money managers.
North Carolina’s pension fund used to have lower costs. In 2000 the state was paying fees of just 0.1 percent of assets, compared with 0.7 percent now. Then it pushed into alternatives. The underlying investment can include everything from stakes in private companies to derivatives linked to barrels of heating oil and bushels of wheat. “I have $900 million worth of timber,” Folwell says. In theory, such investments can provide a hedge against inflation and the volatility of equities.
And at a time when bond yields have been historically low, many big institutional investors have been eager to find investments that might provide some extra return to help meet their obligations. “The U.S. stock market has had a good run, but it’s likely to be unsustainable in the long haul,” notes Josh Lerner, a Harvard Business School professor. For pension funds, he says, private equity in particular may seem like one of the few ways to get a lift.
If North Carolina had owned a vanilla stock-and-bond index portfolio instead of shifting into alternative assets, it would have earned an additional $20 billion over the seven years through June 2016, estimates Ron Elmer, an accountant and indexing advocate. Elmer ran unsuccessfully in the Democratic primary for North Carolina treasurer last year before throwing his support behind Folwell.
Four-fifths of the fees paid by North Carolina’s pension fund last year went to private equity, hedge fund, and other alternative assets that accounted for about one-fifth of the state’s investments. Investing in alternatives also includes extra costs for such things as sending state employees to annual fund meetings, according to Folwell.
Since taking office, he’s been calling money managers to ask about performance, costs‚ and whether they’d work for less. During one call, he says, Robert Kapito, president of BlackRock Inc., tested Folwell on his claim to be a mechanic by asking where the gas goes into a 1951 Cadillac coupe. The New York-based company manages about $15 billion for the state, the majority of which is in low-cost index funds. A spokesman for BlackRock says it applauds Folwell’s focus on getting value for the fund's money.
Folwell says when he replied that the fill pipe is in the taillight, the BlackRock boss said the treasurer had passed his test. “I said, ‘We may talk with an accent, but we don’t think with one,’” says Folwell. “The purpose of these phone calls was for the managers to pass our test, not for us to pass theirs.”
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