Passive aggressive

 In 2015-03

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This past December, a pension-fund research company called CEM Benchmarking Inc. analyzed North Carolina’s retirement fund, the ninth-largest public retirement plan in the United States. The data-crunchers at Toronto-based CEM issued a report to N.C. State Treasurer Janet Cowell with this conclusion: For all the time and money that Cowell and her team of internal and external managers spent on trying to beat the market through increasingly complex investments, the spread between that work and placing the money in comparable index funds was only 0.1%.  This may be the true definition of a rounding error. But with a pension fund that is worth $90 billion, it is also a rounding error totaling $90 million. It is both incredibly hard to move the needle and incredibly important if you are even just a little right on placing your bets.
That is the world of Janet Cowell. She may be the most powerful woman in the state — too powerful if you believe her critics at the State Employees Association of North Carolina — with an expanding empire. Since 2012, she has overseen the State Health Plan, which insures nearly 680,000 public employees and their families and has an annual budget of $2.5 billion. She chairs the State Banking Commission. She is the principal guardian of the state’s Triple A bond rating. Most importantly, she controls the state pension fund, where the assets go and who gets paid for managing them. Though her annual salary of about $125,000 is more akin to the pay of a midlevel banker than a finance-industry CEO, the buck stops and starts with Cowell, the fund’s sole fiduciary. During her six years in office, she and the General Assembly have overhauled how the state invests, aligning Jones Street more closely with Wall Street and taking on more risk for the chance of higher returns. She has said it is an experiment, but it’s with real money, and it needs to work. For Cowell. For more than 900,000 state employees and retirees. And, of course, for the taxpayers.
“She’s a serious person and a straight shooter. Janet is not warm and fuzzy. She’s gracious. She’s friendly. But she’s not warm and fuzzy.”
Pension funds, at their heart, work like this: Employers and employees contribute to the fund, and the fund administrator invests that money and pays retirees a set amount each month. The actuarial calculations that guide those decisions are based on assumptions about contributions, payouts, the rate of return on investments and the life expectancy of pensioners. A mistake in adjusting those figures can have disastrous long-term consequences. State pension funds run into problems — Illinois, Kentucky and Connecticut are three examples — by shorting the employer contributions, offering overly generous benefits or assuming unrealistic returns on investments. North Carolina has the nation’s second best-funded pension, trailing only Wisconsin, according to Standard & Poor’s Financial Services LLC, the New York-based rating agency. Still, its performance has lagged the expected annual return of 7.25% during lengthy periods. Over the past 15 years, the fund, which is technically made up of eight different entities, averaged a 6.2% gain. To fill in the gap, the state chips in more to meet actuarial obligations. That’s why even small increases in yield are important.
To make the target, the state pension requires a strategy that relies on more than passive investments and hoping the rising tide of markets lifts all boats, Cowell says. “At some point, if you miss the target year after year after year, there are political consequences for that. It can get very expensive. Questions will be asked. But I would just say that some of the folks that say, ‘Let’s just go into public stock and public bonds and do it passive, and let’s just call it a day because in the end it will all work out,’ I would say, ‘In America, in this system, in the way we run our pensions, I don’t think that would work out.’”

As her own career shows, Cowell, 46, is not a passive person. She grew up in Memphis, Tenn., daughter of a Methodist minister and a schoolteacher. She earned a bachelor’s degree in Asian studies from the University of Pennsylvania and worked as a financial analyst in Hong Kong and Jakarta, Indonesia, before returning to Penn for a Wharton School MBA. She was an energy-market analyst for Corning, N.Y.-based Corning Inc. before moving to Raleigh in 1997 to work for Sibson Consulting, a human-resources adviser now owned by New York-based Segal Group. She left the corporate world in 2000 to lead development for the Common Sense Foundation, a liberal think tank in Raleigh that pushed for greater fairness in the tax code. It was a difficult job, she says, balancing the organization’s progressive ideals with realities of fundraising. Steve Schewel, a Common Sense director who co-founded Durham’s Indy Week alternative newspaper, says Cowell straddled that divide through hard work and integrity. “She’s a serious person and a straight shooter. Janet is not warm and fuzzy. She’s gracious. She’s friendly. But she’s not warm and fuzzy.” In 2002, she became an independent consultant for New York-based Pfizer Inc. By then, she’d launched her political career, winning an at-large seat on the Raleigh City Council in 2001, aided by contacts she’d made as a Sierra Club member.

In 2004, she was elected to the N.C. Senate, where she ranked as a moderately effective legislator, according to the North Carolina Center for Public Policy Research, a Raleigh-based nonprofit. She won without opposition in 2006. The next year, Richard Moore announced he would run for governor instead of a third term as treasurer, prompting Cowell to seek the statewide office. The Democratic primary pitted Cowell against Raleigh lawyer Michael Weisel and David Young, a former chairman of the state party.  Cowell didn’t raise the most money, but she won 46% of the vote, aided by being the only woman in the three-way race. In the general election, she beat Republican state Rep. Bill Daughtridge, an oil distributor from Rocky Mount, riding the Obama coattails to victory. She was re-elected in 2012, defeating Republican Steve Royal, whose campaign included a call for a regional currency.
Her trajectory surprised many. “I didn’t see that when she walked in the door,” says Linda Garrou, a former N.C. senator from Winston-Salem who was part of a cadre of female legislators when Cowell came to the N.C. Senate. Occasionally, Garrou says, Cowell would invite her female colleagues to her house for a meal after session, showing a desire for consensus and pragmatic solutions. For years, Cowell lived in a neighborhood of smallish homes just west of the N.C. State Fairgrounds, but she recently moved to a larger, more suburban setting in northeast Raleigh. Garrou disputes the notion that Cowell, who is an avid bicyclist and drives a 2007 Acura Integra, is too stiff. “I don’t think she takes herself seriously,” she says. “I think that she takes the job seriously.”

For years, North Carolina’s pension fund was overfunded, its assets exceeding its liabilities on an actuarial basis. But the financial collapse in 2008 wiped out 20% of its value, some $17 billion, and it sunk to $60 billion as Cowell took over. She set out to rebuild the plan by moving money out of stocks and bonds into so-called alternative investments. Cowell won authority from lawmakers to invest as much as 35% of assets in alternatives, up from 20% in 2009. There’s still room to grow, with a quarter of assets currently devoted to more complex strategies, compared with 10% five years ago.

When Cowell was elected treasurer in 2008, her party still controlled the governor’s mansion and both chambers of the General Assembly. The next year, the legislature expanded her powers, over the opposition of virtually the entire House Republican caucus. In 2010, Republicans gained majority power and used that year’s redistricting process to cement their control of the House and Senate. Now, it’s the GOP that is pushing hardest to give her office investing freedom, and Cowell is attentive to the majority. In January, she hired then-state Rep. Edgar Starnes, a Republican from Granite Falls, as special counsel for an annual salary of $65,000. (Her office declined to make him available for an interview.) “We’ve been very pleased with her performance,” says state Sen. Tom Apodaca, a Hendersonville Republican who co-chairs the Pensions & Retirement and Aging Committee. It’s not a matter of helping a Democrat succeed in Raleigh, Apodaca says, but rather embracing an agenda that meshes with Republican principles. “Many of us have business backgrounds, so we understand what she is trying to do.”

“We’ve been very pleased with her performance,” says Republican state Sen. Tom Apodaca of Hendersonville.
Alternatives cover a wide range of investments including real-estate trusts, airplane leases, private equity, hedge funds and inflation bets. What they share in common is they tend to be more complex, riskier and more expensive to manage than stocks and investment-grade bonds. They are also less liquid and tougher to value. It’s easy to know the value of 10,000 shares of Duke Energy. It’s more difficult to appraise an investment in a startup technology company or an office building. It’s also tricky for the public to understand the state’s holdings, partly because financiers investing on behalf of North Carolina prefer not to reveal their strategies. For example, the state fund owns $7 billion of timberland, apartment complexes, office buildings and other real estate. But there’s no public list of assets, which are held through limited partnerships and real-estate trusts — agreements that prevent disclosure. Cowell made an exception for one building, which she cited during an interview. The state bought Two Grand Central, a 44-story office building in Manhattan a block from Grand Central Terminal, for $401 million through a limited partnership in 2011.
Confidentiality is simply the way the world of finance works, Cowell says, and to not engage would only exclude North Carolina from significant investment opportunities. But less disclosure opens Cowell to complaints that she is spending too much on management fees without proper scrutiny. “Our only alternative is blind faith,” says Ardis Watkins, director of legislative affairs at SEANC, which contends Cowell’s decisions have cost money that would have paid for state workers’ cost-of-living increases.
North Carolina paid investment advisers $490.2 million in during the fiscal year ended June 30, an 18% increase over the previous year, which was the first time the state treasurer’s annual report disclosed the statistic. In 2013 the investment costs amounted to about 0.52% of assets, less than most similar-size pension funds. About two-thirds was management fees and the rest was incentives. Most of the incentive fees, some $76 million, went to the firms that advised the state on credit strategies, which includes buying distressed debt and more speculative ventures often called junk bonds. The investments increased by 17.5% in 2013, far ahead of its industry benchmark of 3.3%. One winner was $180.4 million invested with Angelo, Gordon & Co., a New York-based hedge fund that specializes in real estate and distressed debt. The fund made a $98 million profit over four years. But the gain came with a cost — Angelo, Gordon received a $16.7 million incentive fee because of the investment’s success.
Not all the alternatives have been so successful. The state’s hedge-fund investments posted single-digit annual returns in recent years, while the Standard & Poor’s 500 index of U.S. stocks more than tripled since its 2009 bottom. In private equity, performance has sharply lagged the benchmarks. Cowell and her team say results are following what is called a “J-curve,” where payoffs bear fruit only after the assets can be sold, typically within five to seven years.
On rare occasions, Cowell reveals that the state is an investor in a private-equity deal, usually to publicize her commitment to investing in North Carolina companies. But for the most part, there’s no disclosure of where the money is going to work. That galls SEANC, which has pushed Cowell for more transparency, mostly unsuccessfully. “It’s a compounded problem,” Watkins says. “You pick the wrong people. You pay them too much, and they make bad decisions. At some point, you have to choose, if you are treasurer. ‘Am I making bad decisions or am I paying too much money?’” Cowell’s shift to alternatives has cost state retirees $6.8 billion in unrealized value between 2009 and 2013 compared with the potential of more conventional assets, according to an April study sponsored by the 55,000-member SEANC, which is an affiliate of the Service Employees International Union. State and local government workers in North Carolina have no collective-bargaining rights, which limits their power, but they’ve used lobbying tools to attack Cowell. “The Treasurer has betrayed her fiduciary duty by entering into expansive agreements with Wall Street to keep the very details of their abuse of pension assets secret,” according to the study by Ocean Ridge, Fla.-based Benchmark Financial Services Inc.
As part of the investigation, SEANC filed a massive public-records request for contracts the state has with its fund managers. Most were returned, often heavily redacted to the point of uselessness. One, from Charlotte-based Carousel Capital Co., is almost entirely blacked out, except for a paragraph noting that investments involved “significant risks and potential conflicts of interest.”
Finance may operate in the shadows, but state treasurers are in the glare. When a mistake is made — real or perceived — the outcry is fierce. On May 18, 2012, Facebook Inc. conducted its initial public offering, and North Carolina agreed to purchase $26 million of the stock, at $38 a share. But the company, based in Menlo Park, Calif., had told some investors before the IPO about possible difficulties in its mobile business. Sands Capital Management, an Arlington, Va.-based company that bought shares for the state, was not warned, and in the weeks after the sale, Facebook’s stock dropped more than 50% in value.
Cowell’s critics, including those at the Civitas Institute think tank in Raleigh, questioned why the state bought Facebook, speculating she was too cozy with Erskine Bowles, the Charlotte investment banker who is a director of the company and New York-based Morgan Stanley, its lead underwriter. (He is also a co-founder and senior adviser to Carousel.) In August 2012, the retirement fund became one of the lead plaintiffs in a lawsuit filed in U.S. District Court for the Southern District of New York against Facebook and Morgan Stanley, contending the two companies violated federal securities law by not adequately disclosing revenue projections. The case is pending, but a funny thing has happened. Facebook’s shares, after dropping to as low as $18, are now about $75. Because North Carolina is a litigant, it has had to hang onto its shares, and its stake exceeds $50 million. “The lesson is that things can get really screwball,” Cowell says.
Cowell and her staff pushed back against SEANC, a typically Democratic-leaning group that is in turmoil after the February resignation of longtime President Dana Cope amid charges he misappropriated the organization’s funds. The state’s chief investment officer, Kevin SigRist, says that Cowell complied with disclosure laws and has made the department more transparent in describing who manages the money. SEANC’s point that the state would be better off had it kept more money in stocks instead of diversifying misses the point, he says. Diversification helps spread risk, especially when stocks are at record highs and yields from bonds are at historic lows. “We try not to be daily focused,” he says. “Our true investment horizon is about 30 years. So when we’re thinking about this decision, how much risk to take, we’re looking at 10-, 20-, 30-year horizons.”
The size of North Carolina’s holdings and its long-term obligations make it hard for the fund to dart in and out of holdings like a nimble trader. With $39 billion invested in stocks, North Carolina’s fund ends up riding the same general currents as the S&P 500 or the Russell 2000. Outperforming benchmarks requires adroit allocation decisions, such as deciding how much to invest and then hold in large-cap or mid-cap stocks, whether to sell bonds and buy real estate, or to move into more obscure areas, like buying distressed debt. “When you have that much money, you are the market,” says Bill McGee, a former Republican state representative from Clemmons who worked for a year as an aide for Cowell and praises her management skills. Because many other pension funds are pushing hard into alternatives, the flood of new money raises prices and pushes down returns, says Gregory Mennis, director of public-sector retirement systems research at The Pew Charitable Trusts in Philadelphia. Some are reversing course: California Public Employees’ Retirement Systems, the largest U.S. public pension, said in September it would shed its $4 billion investment in hedge funds, citing their expense and complexity.

North Carolina is one of four states — Connecticut, Michigan and New York are the others — in which a single elected official acts as sole fiduciary for public pensions, rather than a board. A year ago, Cowell convened a commission to study whether North Carolina should move to a power-sharing model, as favored by SEANC. The commission agreed broadly on creating additional oversight for the pension fund, but split on whether to abandon the current system. Cowell wants any deal to include much wider latitude on asset allocation, which remains set by statute.  Flexibility, she says, is the key to performance and stability. “I’m willing to give up my authority,” she says, “if they’re willing to give up theirs and put it in a board. But if they’re not willing to give up their authority, then this does not work.” The issue may be a moot point because Senate President Pro Tem Phil Berger likes the sole-fiduciary model.

No matter who is in charge, the overriding problem is that states want to wring greater returns from their pension funds without making adequate contributions, says Andy Silton, who served as the state’s chief investment officer under Moore, Cowell’s predecessor. “When things don’t turn out, the fiduciaries get blamed, but typically it’s the lack of funding that screwed it up.” But he sees one strong argument for a new approach. “My biggest concern with the North Carolina model is that one day we elect a treasurer who doesn’t know anything about investing. We’ve been pretty well served. Boards make people more comfortable.”
Cowell isn’t a one-woman show. SigRist earned $351,000 last year, making him the state’s highest-paid employee outside the university system. His predecessor, Shawn Wischmeier, doubled his salary when he took a job in 2012 as the chief investment officer at the Eden Prairie, Minn.-based Margaret A. Cargill Philanthropies, which then managed $6 billion. During the 2014 session, she received approval to hire 10 people in the asset-management group and create a salary structure that offers incentives more in line with Wall Street than state government. Additional compensation costs will be offset with reduced external fees, she says. Salaries for the new hires have not been set.
With her business ties and nonpartisan reputation, Cowell may be one of a handful of Democrat office-holders well positioned for a U.S. Senate or gubernatorial bid. “I think Janet occupies a very unique position from the 5,000-foot level,” says Scott Falmlen, a former executive director of the N.C. Democratic Party. “She is well regarded by Republicans and, of course, Democrats.” She’s no backslapper, but she has organizational strengths and an authenticity that impresses voters, he says.
Richard Moore’s predecessors, Edwin Gill and Harlan Boyles, each retired from the job after 24 years. Boyles was seen as an avuncular sage on fiscal matters in Raleigh, nearly above politics, ambition and the money managers grubbing over assets. He retired at age 71. Cowell, by contrast, gives no indication she wants to be treasurer for life. “I could do this again or look at different options, probably at some point, next year,” she says. Robert Clark is a professor at N.C. State University and expert on pension plans who chaired Cowell’s Future of Retirement Study Commission and came away impressed with her data-driven approach. They still meet for coffee now and then. If Cowell doesn’t seek higher office, he envisions her next career in higher education or philanthropy. “She’s smart. She’s got good ideas. She’s viewed as a reasonable person.” The private sector is an option, but that is complicated by revolving-door restrictions she has implemented that limit the type of work she and other department staffers can do after leaving state employment. The restrictions range from six months to six years, depending on the particular job.
The treasurer’s duties are more objective than many state jobs, Cowell says, so there are measurements of performance, such as the pension’s rate of return, that voters can seize on in a hurry. The fund’s return in fiscal 2014 was 15.9%, compared with a 15.7% median return of large U.S. pensions compiled by the Wilshire Trust Universe Comparison Service. “Treasurers can be tricky offices to run from,” she says. “There’s a lot of asymmetric risk in this office. That’s another investment term I hear a lot. Your upside is capped but your downside is endless. The good news is that we’ve kept performing, but that hasn’t exempted me from a lot of criticism. Just think if I wasn’t performing well what my life would be like.”
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