Pine Belt Progressive

Two questions that have been plaguing me since the PACT fiasco started are:

“Was the money invested conservatively?”

“Was it invested responsibly?”

I’ll make my best effort to answer these questions here.

Variability of returns is one way to measure risk. Let’s begin with that.

The chart below shows PACT’s percentage return on investment (ROI) for the last 18 years. I also added percent funded. I assume that means the percentage of the program’s total obligations (i.e. NOT just payouts due that year) that are funded at each interval.

Look at the average (mean) ROI. That’s pretty close to the official projection of an 8 percent per year return.

With a conservative strategy, you would see lower returns than this in the good years. You would also see a smaller difference between the best and worst years.

Here’s another way to evaluate the variability. What happens when we put the annual return on investment in order from best to worst?

Only five years below the projected 8%.  If we divide the 13 good years by the 18 total years, it gives us a success rate of 72.22%. In ten of these years the ROI exceeded the projected 8% by more than 50 percent. That’s a “highly successful” rate of 55.55%. All that success still isn’t enough to make up for the five bad years. Note the range between the best and worst years, too – it’s more than 45 points!

This amount of variability is a red flag. Based solely on the variability, If someone says PACT has been conservative with this money, we may want to ask them: Are you ignorant, or are you lying? But let’s not be too hasty about that. Let’s look at this from another angle, first.

Investment Strategy Evaluation

Here’s a second way to evaluate the risk. We can compare the investment strategy adopted for PACT to the strategies recommended for 529 funds participants.

One way to do this is to look at Van Kampen’s strategies for Alabama’s 529 savings fund. This one is explicitly described as a mutual fund with all the risks attendant. I hope this comparison will make it clear that the PACT monies were invested irresponsibly.

According to page 4 the actuarial report, (see page 9 of the pdf file) more than 60% of all contracts have anticipated enrollment dates in 2011 or before. An additional 15% have enrollment dates between 2012-2014.

Now, check out the “years to enrollment” investment strategy distribution from page 4 of the 529 brochure (pdf). See how stocks make up only 10% of the portfolio for those entering college within 2-3 years? And 50% for those enrolling in 4-6 years?

Compare the 529 strategies to the investment strategy in the actuarial report (p.9):

U.S. Stocks: 51%

Non-U.S. Stocks: 21%

Fixed Income: 28%

According to the report, fully 72% is invested in stocks! That is only a few points less than the percentage recommended by the 529 program for those who are expected to enroll in 9-7 years under an “aggressive” (highest level of risk) investment strategy.

While it may be legitimate for a wealthy person to pursue an aggressive “high risk/high return” strategy and hope for an annual growth rate of 8.5% over an 18 year period of time, we’re talking about the money of average Alabamians here. This group of people just can’t afford to take these kinds of risks with their childrens’ college money.

And keep in mind what the “moderate risk” investment strategy for the 529s looks like. It includes a maximum of 60% stocks for those who are enrolling in 10 years or more, then cuts back to 50% for those enrolling in 9-7 years.

So it appears that PACT engaged in an investment strategy that would be considered an appropriate “high risk” strategy for those entering college in 7-9 years, despite the fact that approximately 75% of their contracts are for students enrolling in 2014 or earlier.

It is unacceptable for 72% of these investments to be in stocks, given the a general rule that the closer you get to “paying out”, the less you put in stocks, and the more you put in non-volatile or insured investments like bonds and certificates of deposit. And given the near-term obligations of the fund.

Further Questions

Based on what I’ve seen here, this money was handled neither conservatively nor responsibly.

Alabamians deserve to know why the custodians of this money thought it was a good idea to invest it the way they did.

This is the basic analysis. We haven’t even begun to consider the difficult questions. Here are a few questions I think the citizens of Alabama deserve to have some answers to, just for starters:

Who adopted this investment strategy, and on whose advice?

How long has this investment strategy been in effect, and what did the strategy look like before it was adopted?

What are the details of these U.S., Non-U.S., and Fixed-Income portfolios? Which companies and which bonds is this money invested in?

What is the role of the securities lending program mentioned on page 4 (pdf page 6) of this report? What type of securities are being lent, and to whom? Where is the collateral being invested?

Reporters and Legislators ought to ask these questions. The PACT board ought to answer them.

– I am indebted to Paul Lukasiak for his patient analytical assistance, and for the many words he has exchanged with me over the last couple of weeks on this issue.

– Data source for the tables

Cross-posted at Left in Alabama