Cindi Ross Scoppe

What if we replaced the geniuses with an index fund?

Sacramento Bee

I’VE SUPPORTED all of the efforts to allow our state pension funds to be invested more aggressively. Not because I’m an aggressive investor myself; far from it. But I figured the state of South Carolina was more sophisticated about investing than I am, and would buy good talent to invest the money well.

I was wrong. Seventeen years after we finally allowed State Retirement System funds to be invested in stocks, we have traded a pension system that could meet 100 percent of its obligations for one that meets just 62 percent. That translates into an “unfunded liability” (read: debt) of $20 billion.

We need to face facts: When it comes to investing, we’re incompetent.

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Our legislators’ special pension perk

Schools, cities, counties to pay much of cost of pension fix

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You know how responsible investment advisers say you shouldn’t try to time the market? Well, South Carolina’s investment geniuses have repeatedly timed the market to near perfection — in reverse: getting in just before the crash, getting out just before the boom. Hence (among other reasons) the $20 billion debt.

Insanity, you might recall, is doing the same thing over and over and expecting different results. We haven’t done precisely the same thing over and over, but it fits a clear and disturbing pattern: Ever more aggressive — read “risky” — investments. Ever higher fees and expenses. Ever lower returns.

To fix the problem, lawmakers need to do three things: 1. Stop losing money. 2. Pay down the debt. 3. Make changes to our governance and benefits to prevent future problems.

Some of the changes that a joint House-Senate pension review panel endorsed on Wednesday seem sensible: Putting more money into the pension system right now is a big one, although we can’t afford to simply buy our way out of the hole. Eliminating the state treasurer’s odd role in the system is also important.

Some changes are less sensible. Chief among them: capping contribution rates for employees. A 2012 law required that employer (state and local agencies) and employee rates rise together, to make it less likely legislators would keep adding more benefits to the overburdened system. Without that linkage, we lose that protection.

While the panel’s plan looks on paper like it will stabilize the system, it only works if we achieve a 7 percent rate of return on pension investments. That’s less unrealistic than the 7.5 percent goal in state law, but it’s still unrealistic. And any improvement will be because of the transfusion, not because we stopped the bleeding.

To digress slightly: I do not mean to suggest that state Treasurer Curtis Loftis’s accusations of fraud have been accurate or responsible. I believe he has been a political opportunist, and I believe his shrill, reckless allegations have exacerbated the problem, pushing responsible people to defend the system rather than demanding changes sooner. That is one of the many reasons he should not be a member of the Investment Commission, but should merely be able to appoint one of its members — just like the other four elected officials who used to run the system, and as the legislative panel recommended.

But he is right when he says we have been spending too much money on expenses and we have to make drastic changes to stop losing money. Since the hole is getting deeper, we have to stop digging.

My own decidedly unsophisticated and unaggressive investment strategy relies heavily on stock index funds, which mimic the wider market performance. I’m not getting huge returns, but they’re a lot better than what South Carolina is getting.

A Legislative Audit Council report released in December 2015 noted that the Vanguard Balanced Index Fund outperformed the state’s pension plan in nine of the previous 10 years. And that was before the state pension fund actually lost money last year. On top of the better returns, the index fund has a 0.22 percent expense ratio, compared to the state’s 1.57 percent.

The Post and Courier’s David Slade reports that Georgia’s pension fund, built around low-cost stock and bond funds, had better returns than South Carolina’s in the five years following the 2009 market crash. And it got those returns by spending a tenth what we did — $13 for every $10,000 invested vs. our $156.

The difference was even more dramatic in Nevada, which spent $18 million in fees and overhead last fiscal year, compared to $247 million we spent. Both sound a lot better than what’s happening here.

Michael Hitchcock, who runs the S.C. Retirement System Investment Commission, has dismissed the idea of (slowly, carefully) switching South Carolina’s pension funds from active to passive investment, noting that there’s no way index funds will generate a 7.5 percent rate of return. And he’s right.

But here’s the thing: We’re not getting 7.5 percent now. Our 10-year average rate of return is 4.5 percent — 3 points below the goal, 2 points below the overall U.S. stock market and almost 2 points below the Vanguard Balanced Index Fund.

No, we probably couldn’t get even a 7 percent return in index funds. But we’d do a lot better than we’ve been doing, and we’d save hundreds of millions of dollars a year on overhead.

Maybe that wouldn’t stop the bleeding. But it would slow it from life-threatening to annoying.

Ms. Scoppe writes editorials and columns for The State. Reach her at cscoppe@thestate.com or (803) 771-8571 or follow her on Twitter or like her on Facebook @CindiScoppe.

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