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Asset Management CultureMarch 13, 2020

NC State Pension Weathers Market Turmoil Well as Others Crumble

‘You can’t be a gambler, and you can’t profess to have a crystal ball,” says state treasurer Dale Folwell.

North Carolina State Treasurer Dale Folwell has taken heat in the past couple of years for what some have said is an overly conservative investment approach. Critics said the pension fund was missing out on a charging bull market when he moved billions of dollars from equities into fixed income.

But Folwell’s slow-and-steady-wins-the-race approach now looks quite prescient amid a global markets crash that shows no signs of abating.

While many of the world’s largest pension funds have been hammered over the past couple of weeks by plummeting global markets, North Carolina’s $105.6 billion state pension fund has fared far better than its peers thanks to the fund’s conservative investing approach.

At the end of last week, when many of the largest pension funds and sovereign wealth funds were down as much as 6%, North Carolina’s state pension fund was down less than 1%. And although the pension fund is now down at least 2.7% as the markets continue to plummet this week due to coronavirus fears and plunging oil prices, the fund is still doing much better than other major institutional investors.

For example, the California Public Employees’ Retirement System (CalPERS) has lost approximately $29 billion, or more than 7% over the past two weeks, with its asset value falling to $370.99 billion as of market close on Wednesday. And the $250 billion California State Teachers’ Retirement System (CalSTRS) said the market downturn “took about 4% off our total return,” according to CIO Chris Ailman—and that was before this week’s market bloodbath.

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Norway’s Government Pension Fund Global, which a couple weeks ago reported record 2019 returns of $180 billion, has since lost well over $100 billion, or more than 10% of its value, as the world’s second-largest pension fund’s value fell from $1.07 trillion to $961.4 billion as of Wednesday. According to a report from The Guardian newspaper, UK pension funds lost an estimated 5% to 6% of their value, also before this week. And the S&P is down over 25% over the past month alone as of Wednesday.

In an interview with CIO, Folwell attributed the fund’s ability to withstand the tumbling markets better than others to conservative investing from his investment team and a strong funded position. The state’s Local Governmental Employees’ Retirement System has a funded ratio of 90%, and the Teachers’ and State Employees’ Retirement System has a funded ratio of 86.4%.

“All the credit goes to the team—we have co-CIOs who have between them over 50 years of experience in the business,” Folwell said. “This has been a very conservatively managed plan, and, for the most part, as our equities have declined, our fixed-income portfolio has gone up to offset much of that.”

Over the past couple of years, Folwell has shifted approximately $11 billion worth of equities in the fund to fixed-income investments. And he took a lot of criticism in doing so during a bull market that showed no signs of waning.

In a blog post this past December, Andrew Silton, the former CIO of the North Carolina Retirement System, was critical of Folwell moving the pension fund out of alternative investments.

“While it is certainly appropriate for the treasurer to question the efficacy of alternative investments and engage in a refinement of strategies and the pace of investments, it appears that Treasurer Folwell slammed the brakes on these investment efforts,” Silton wrote. “This is bad news for the pension.”

And in a January 2019 Wall Street Journalcommentary, Mene Ukueberuwa wrote that “true to his word, Mr. Folwell halted new investments in private equity and reduced fees by shifting funds into cash and bonds. But by year’s end those savings were dwarfed by the potential earnings the fund missed as the private and public markets surged.”

But Folwell has shrugged off the criticism, saying that the critics only focus on returns, which he said is only one of three main priorities he’s concerned about.

“We have three legs of our pension stool: We got risk, we got return, and we got the ability to fund,” he said. “When you have one of the largest pools of public money in the world that nearly one out of 10 adult North Carolinians are depending on, either now or sometime in the future, you can’t be a gambler, and you can’t profess to have a crystal ball.”

A big reason the North Carolina state pension fund has been able to take a conservative approach is because of its high funded levels. According to Moody’s Investors Service, North Carolina’s Retirement Systems is the best funded in the US in terms of its adjusted net pension liability. And according to The Pew Charitable Trusts, North Carolina “shows especially well” in stress test analysis thanks to a strong funding policy and funding levels.

“The people who teach and the people who protect and otherwise serve our citizens, they don’t wake up thinking about asset allocation models and assumed rates of return,” Folwell said. “They want to make sure that the pension plan that they have worked for for 30 years is going to be there to support them.”

UK Defined Benefit Code Revision ‘Biggest Revolution’ in 15 Years

The Pensions Regulator publishes consultation on British defined benefit investing regulations.

By Michael Katz

The Pensions Regulator (TPR), the UK’s pension watchdog, has published its first consultation on principles it will use to regulate how defined benefit pension plans are funded and invested. This is expected to be “the biggest revolution to the requirements for pension funding and investment in 15 years,” according to actuarial consultancy firm Lane Clark & Peacock.

In 2018, the British government published a white paper that said some aspects of the defined benefit funding framework needed to be improved, such as greater transparency and accountability concerning risks being taken on behalf of members and employers, and that trustees should focus on the long-term strategic issues for their plans. It also highlighted some gray areas in the existing framework relating to how trustees should set technical provisions and an appropriate recovery plan.

“This lack of clarity has enabled a minority of schemes and employers to misuse the flexibility in the system and made it more difficult for us to regulate DB schemes,” TPR said in its consultation.

The consultation asks the pension industry for its views on proposed principles for the funding of defined benefit plans and how they could be applied through more detailed guidelines. TPR said this will enable it to set a clear benchmark for good standards of compliance. The revised defined benefit code will implement measures set out in the Pension Schemes Bill that was introduced in Parliament in January. TPR said it expects the revised code will come into force at the end of 2021.

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The regulator is proposing a “twin-track compliance” approach to valuations, which is intended to allow trustees to demonstrate that their valuations are compliant with legal requirements. Under the proposals, trustees would be able to choose either a “Fast Track” or a “Bespoke” approach to completing and submitting a valuation of their scheme.

According to the consultation, the Fast Track approach will be relevant for trustees who can submit a plan valuation and recovery plan that is compliant with TPR’s guidelines. Their valuation submission will receive minimal regulatory scrutiny, and it is expected to ease the process for many well-managed and well-funded plans, as well as help the trustees of small plans understand what they need to do.

And the Bespoke approach would be for plans that choose not to or can’t comply with the Fast Track guidelines, such as plans that want to take on more investment risk or have affordability constraints. Those plans would have to submit their valuation together with a statement of strategy and supporting evidence that explain how they meet TPR’s principles, the legislative requirements, and, if relevant, how any additional risk is supported. TPR said it would apply more scrutiny to plans taking the Bespoke approach but added that they would be considered equally compliant with the legislation “if done properly.”

Regarding investing strategies by pension plans, the TPR said it expects all plans to take only a level of investment risk that is supportable, and it sets out proposals for how trustees could demonstrate whether the risk in their investment strategy is supported, such as through a stress test.

The stress test TPR is proposing is intended to incentivize plans, particularly mature ones, to invest more in bonds. But it also said there are alternative actions that plans may use that could reduce the impact, such as increasing their level of interest hedging without changing their total bond allocation by using longer dated bonds or by taking advantage of liability-driven investing and other leverage or derivative strategies.

“This would provide a better protection … against a fall in interest rates and a lower level of downside investment risk relative to the liabilities,” TPR said in the consultation. It also said that although government bonds are an important part of any long-term asset allocation, plans could choose to use corporate bonds or other bond-like investments to a greater extent.

TPR also proposes setting a limit on the percentage of investing in growth assets. It said that it considers “having a high resilience would be consistent with having a relatively low percentage of growth assets.”

Dan Mikulskis, a partner at Lane Clark & Peacock wrote in a blog post that plan sponsors and trustees should review their investment strategies to consider whether changes are needed. He suggested they ask the following questions:

Would my investment strategy meet the Fast Track test today?
What about in five years’ time? What if the covenant got downgraded?
How are we planning to be invested when we reach a significantly mature state?
How is the investment strategy going to evolve to get there?
Does this align with the evolution of the Technical Provisions discount rate?

“One possible consequence of the new regulatory funding regime could be increased sponsor engagement on investment strategy,” Mikulskis wrote. “So trustees ought to be ready to respond thoughtfully to sponsor proposals, or to plan to get on the front foot with their own proposals and negotiate a mutually agreeable position and journey forward where possible.”