Review of Wyoming Treasurer Office Presentation “Historical Investment Returns,” August 24, 2020.

Jeff Hooke, August 28. 2020

1

Summary

• TheWyomingpermanentfundsarethevictimsofModernPortfolioTheory(MPT),aportfoliomanagementstylethathasbeeninvogueforthelast25years.

• UnderMPT,institutionalmanagers,liketheTreasurer,replaceaportionoftheirlow-feetraditionalinvestments-- likepublicstocksandbonds-- withhigh- feealternativeinvestments-- likeprivateequityandhedgefunds.SeeFigure1.

• Theideaisthatthehigh-feeproductsenhanceprofitsoverthetraditionalmodel,althoughseveralindependentstudiesthelastcoupleyearshavetotallyrefutedthisidea.Infact,MPTreducesprofitsversusthetraditionalmodel.

Figure 1

Traditional Portfolio vs.

Modern Institutional Portfolio

STOCKS

BONDS

Infrastructure

Commodities

Real Estate

Private Equity

Hedge Funds

Bonds

Stocks

Core

Satellite

WhyDoInstitutionalMoneyManagersuse

MPTifitDoesn’tWork?

• ManydonotreadstudiesthatcontradictMPT,sincethestudiesmostlyappearinobscureacademicjournals,onlysometimesreachingthenewspapers.

• Somerefusetobelievethestudies,evenifastudyhasbeenreviewedbytwoNobleLaureates.

• Somethinktheycanbeattheaveragesoftheirpeersandsimplepassiveindexes,byusingthepriceyalternatives,evenwhenWarrenBuffettsaysmostshouldindex.

• Somethinkindexingwillhurttheircareers,sinceyouseemsmarterifyoubuymanycomplexinvestments.

Page1ofTreasurerPresentation

• Wyominggoalsandobjectivesarelikeotherinstitutional

investors,notparticularlyuniqueassuggestedbythe

Treasurer.

• Thestateguidelinesdonotmaketheportfoliostyleforthe

permanentfundsanydifferentthanmostotherendowments,

statepensionplans,sovereignwealthfundsorfoundations.

• TheWyofile storydoesn'tanyspecialcherrypicking.

Page2

• TheWyomingfundshaveaequitytototalassetratiothatislowerthanitspeers;thismeanslowerreturnscomparedtoitspeerswhenthestockmarketrises,andhigherrelativereturnswhenthestockmarketfalls.

• Abettercomparatorinthearticlewouldhavebeena50-50index,ratherthan60-40,butthisdoesnottrulychangeconclusions.

• Thepermanentmineraltrusthasanequityratioof65%todaybutthiswasaround50%in2012.

• NewMexicoandAlaskasovereignfundsdonothaveequityratiosof70%ormoreassuggestedbythepresentation.

Page3

• NotsurewhytheTreasurermentions2009,whichis11years

ago.

• TheSLIBpolicyislikemostinstitutions.SeeFigures2and3.

• TheWyofile storycovers10yearsbuttheunderperformance

wouldalsobeevidentfordifferenttimeperiods.

• Mostconsultantsuse1,3,5and10years.

Figure 2

Principal Institutional Investors

Pension Funds

Sovereign Wealth Funds

University Endowments

Foundations

Fund of Funds

Insurance Companies

Wealth Managers &

Family Offices

Figure 3

Institutional Investors’ Portfolio Objectives

Institutional

Investors

Preservation of Capital

Reasonable Rate of

Return

Moderate Risk

Page6

• IftheTreasurerbelievesthatthe60-40willdolousythenext

10years,heispredictingabadstockmarket.

• Heshouldthereforesellsomeofthefunds’stocks,MLPsreal

estate,PE,etc…

• Or,tosavefees,justusea40stocks/60bondsindex…..more

downsideprotectionthana60-40

Page7

• Mostconsultantsdonotfavorusingatwo-yearyardstick.1,3,5and10yearsarecommon.

• The60-40isstillthegoldstandard.

• Lately,institutionsthathavenot“beaten”the60-40indexwanttousetheMSCIACW60-40index.

• Thethepoorperformanceonint’lstocksmeanstheMSCIACWisweak.

• Thetacticislike“shiftingthegoalposts”tomakeiteasierforinstitutionstowin.

Page8

• Thechartisprobablybasedonsomeself-madeRVK

benchmarkthatneedsthirdpartycorroboration.

• RVKisgettingpaidbytheState,sothestateshouldcheckthe

RVKchart,giventheamountofdollarsinvolved.

• Abettercomparatorisanobjective,non-customindex,likea

50-50index.

Page9,Indexit?

• AlloftheFunds’assetclasseshaveindexfunds,suchasUSstocks,int’lstocks,bondsandrealestate(REITs).TheTreasurerdoesnotseemtoknowthisfact.

• Privateequityissimilartopublicstocksinmanyways.

• Hedgefundsareusuallyacombinationofpublicstocksandbonds.A60-40indexhasoutperformedhedgefundseasilythelastfewyears.

• Internalmanagementwillcutcosts,butindexingwillcutcostsevenmore,withoutsacrificingreturns.

Page10

• Thereisalonglistofindependentresearchthatshowsthat

activemanagerscannotbeatanindexaftermanagement

expenses.Thatbeingsaid,peoplekeeptrying.

• Thisgoesforbondsandstocks.

• Thecomparisondoesnotshowthesalariesandothercostsof

in-housemanagementintheyields.

Page11

• Page11isapopularpagewithinstitutions.

• Withitsconsultant,theinstitutioncreatesa“customindex,”

whichtheinstitutionthenalwaysbeats.

• Thisislikeachild“gradinghisownhomework.”

• Itcan’tstanduptoindependentscrutiny.

Page12

• Internationalstocksarecheaperforareason.

• ManyprofessionalsconsiderthemtoberiskierthanUSstocks.

Page13

• True,theUSstockmarketisverytechdependent.

• Thetopfivebiggeststocksnowaccountfor20%oftheS&P

500indexbytotalvalue.

Page15,conceptconfusion

• Today’s64%equitycommitmentbythePMTFisgreaterthan

thatofNewMexicoandAlaska.

• However,thisequityexposureisconsistentwithmanystate

retirementplansanduniversityendowments.

Page16,Fees

• Wyomingfeesareunderstated.

• IfyoulookattheStateofNewJerseypensionplan,whichdiscloses

bothfixedfeesandcarriedinterest,NewJersey'shedgefundand

PEfeesareabout2.5%ofsuchassets.

• ForWyoming,suchfeesshouldthustotal$50millionalone.Adding

50basispointsfortheotheractiveassetclasses,placesthefee

totalmuchhigherthan$47millionindicated.

• Likemostinstitutions,theWyomingfundsignorecarriedinterest

feesbecauseaccountingrulesprovidetheoptiontodoso.

• JeffHookeisaseniorfinancelectureratJohnsHopkinsCarey

BusinessSchool(Baltimore,MD).

• Heisaformerinvestmentbankerandprivateequityexecutive,

whohaswrittenseveralfinancebooks.

• Hehasco-writtenseveralstudiesoninvestmentreturnsat

statesandfoundations.