Sunday, October 31, 2010

Trick? Or Treat?

Portfolio performance through 09-30-2010:
+9.6% for the third quarter,
but negative over the past three years.

Maine state employees and retirees got some good news earlier this month when MainePERS trustees reported a gain of 9.6% in the pension fund's market value from June 30 to September 30. A string of quarters like that will go a long way toward closing the gap (estimated at over $4.4 billion) between the projected benefits due future retirees and the resources currently expected to be available.

But the state's investment in the financial sector continues to diminish returns. Two large equity holdings, JPMorgan Chase and Bank of America, have dropped out of the portfolio's Top Ten, not because shares have been sold, but because the shares held (over a million shares of JPM and 2.5 million shares of BAC) have underperformed relative to other investments. Since financial-sector stocks peaked on April 15, JPM's stock price has fallen by 21.9% (as of last Friday's close) and BAC's by twice that, 42.4%. That's over $20 million up in smoke.

According to a MainePERS spokeswoman, MainePERS domestic equities are "100% passively managed." In other words, fund managers are not in the business of picking winners and losers. They buy the entire market and hope for protection through diversification. That's fine if the market goes up, not so fine otherwise. With the broad economy working its way through a painful transition, what we are left with is not a stock market, but a market of stocks. Some will advance, but most will stagnate.

How are the Ivy Leaguers doing it? This is how:

Notice that Harvard allocates 33% of its endowment portfolio (as of June 30, 2010) to publicly traded stocks. MainePERS, by contrast, has over 63% in stocks. MainePERS knows that it is overexposed to equities and aims to reduce its allocation to 55% eventually, still two-thirds higher than Harvard's. Harvard has also gone to 2% cash as a way of improving the "flexibility of the portfolio we are managing today," part of its renewed commitment to "attend closely over the last two years to liquidity, capital commitments, and risk management." MainePERS? 0.5% cash on the way to zero. Voilà some of the differences between active and passive management. "De-risking," Harvard calls it. Yale's exposure to public equities is even less--16% on June 30, down from 34% the year before.

In an environment which calls for sharpshooters with rifles, not shotguns, MainePERS may have the wrong weaponry.

[update, 11-04-10:]

Check out this piece on Bank of America. Remember, if you are a Maine taxpayer or MainePERS enrollee, you own this company.

[update, 11-07-10:]

According to former bank regulator William K. Black, "putting Bank of America into receivership is the proper remedy for its substantial violations of the law and for its continuing reliance on unsafe and unsound practices. Outside reviews have documented the most extensive and financially harmful violations of law and unsafe banking practices and conditions in history." Black further states that "demands by investors that Bank of America repurchase loans and securities sold under false 'reps and warranties' may cause exceptional losses." I repeat, Mainers own 2.5 million shares of of this zombie.

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