Riley: How to Start Fixing the Rhode Island State Pension Fund

Tuesday, April 21, 2015

Michael G. Riley, GoLocalProv MINDSETTER™

On February 25th, new Treasurer Seth Magaziner held his first meeting as Chairman of the State Investment Commission, responsible for the prudential investment of the State Pension Fund Assets in order to fund previous promises. As part of the normal agenda, the CIO reviewed the performance of the Pension Fund and clearly stated that for calendar year 2014 the return was 4.4%. That return was a full 310 basis points lower than the commission had projected through its discount rate. The 4.4% return was lower than the S$P 500 return of 11.44% by 700 basis points and Magaziner was apprised that the State return in Fiscal 2015, which ends in June, was down .7 % versus the S&P 500 +2.00% return over the same period. The shortfall to the pension fund due to lack of returns is in the $500 million dollar range.

Campaigning, Seth Magaziner told us that returns on investments were the most important determinant of pension stability so he can’t be happy with the performance thus far. There is something materially wrong with his very complex and expensive portfolio but because he has never managed money, despite campaign claims, he seems at a loss for words as to what is going on here. Tensions must be mounting between Raimondo, who left Magaziner with a mess, and Magaziner who actually has very little knowledge and zero experience managing any money anywhere.

In the interest of saving the state a little money and Mr, Magaziner a little embarrassment, here's how to fix the pension fund. Liquidate the $1.2 billion invested in equity and real return hedge funds. They returned 4.2% over the last year 720 basis points below the S&P 500 and this would also eliminate 24 different hedge funds that paid 46 million in management fees (fy 2014). Instead, we would replace the entire hedge fund exposure with a truly hedged position that reduces volatility and protects principal at a very low cost. This strategy is called “defined outcome” investing and I am a proud to be associated with the pioneers of this strategy. Rhode Island could have invested instead in a a protection strategy with the following characteristics- A firm, no wavering protection on the downside of 12.5%.

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That means that if the S&P 500 were to fall 30 % like 2008 the state would have only lost 12.5%. On the upside, the state would perform exactly as the S&P 500 with a cap of 15%. So in calendar year 2014, the state would have made 11.66% but would have been protected on the downside and have volatility similar to the hedge fund portfolio. So the performance was nearly 3 times the return of the hedge funds, and to top it all off, the fees would have been about $10 million, or $ 36 million less than the state paid 24 hedge fund managers. This is just one change to an underperforming, massively complex and expensive portfolio.

Riley: How to Start Fixing the Rhode Island State Pension Fund

Related Slideshow: Top Providence Pensions

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