January 12, 2003

How the NTMA blew your €750m

Posted in ·
Share 

Minimising debts and maximising assets are chalk and cheese, yet in Ireland we are prepared to give over €1 billion a year to an agency that has absolutely no competence in asset management. Extraordinary!

Is it just me, or are you amazed at the lack of coverage given to the National Treasury Management Agency’s (NTMA) mishandling of the National Pension Reserve Fund? Last week, the government agency with its posh offices down on Grand Canal Street calmly announced that it had blown €750 million on the financial markets last year. This is close to €200 for every man, woman and child in the country.

Yet the silence was deafening — apart from the usual bland press release on New Year’s Eve, not a dickie bird from Treasury Buildings. Nobody questioned the competence of the committee charged with overseeing the fund. Nobody asked why the chairman of our pension fund was also the chief executive of a company that is being investigated by the Securities and Exchange Commission in the US for accounting irregularities that occurred on his watch.

On most of these issues we should give the benefit of the doubt. Journalists can point the finger unfairly at those doing their best when sometimes simple human error and miscalculations are at play. So, for example, we can put the loss down to the way the markets have performed, adverse moves in the currency and so forth.

However, the benefit of the doubt is predicated on the pension fund authorities explaining their side of the story to the shareholders.

I phoned the NTMA four times during the week to get its side of the story, and the calls were not returned until very late in the week, after I specified that this paper was interested in investigating its performance. We can only assume that somewhere along the way the well-paid and clearly not very competent managers of the fund have forgotten that me, you and your family are the shareholders, and as a result, we pay their wages.

How can National Pension Fund administrators lose so much money without explaining themselves?

* First, why are people with no experience in asset management and equity markets given €1 billion a year to `invest’ in global stock markets?

* Second, what (if any) asset allocation model do they use?

* Third, how did they lose €750 million in 2002?

* Fourth, what are they doing with our money next year?

* Fifth, what is their view of the future predicated on?

* Sixth, what on earth are they doing investing in a buyout fund — one of the most speculative punts you can have on the financial markets?

* Seventh, why do we not know? It is our money, after all.

The answer to the first question is pretty straightforward. Where is the experience? To the best of my knowledge, the head of the NTMA has no experience in equity markets.

Managing debt is a totally different skill to managing assets — one is saving money, the other is making money.

Yes, the national debt burden did come down while he was boss of the NTMA, but so too has the monthly cost of my mortgage. The huge savings on the national debt are a result of the sharp fall in interest rates in Europe and worldwide.

The NTMA is as much uniquely responsible for the fall in the cost of the national debt as you are for the monthly fall in the cost of your original mortgage over the past seven years. Lucky debt managers have no experience of managing a global portfolio of stocks.

Second question. What asset allocation model do they use — or do they have one at all? Every asset manager needs a financial framework in his head to rationalise what he is doing.

Granted, these models can be dismissed as `GIGO’ — garbage in, garbage out — but some framework is needed to assess the most fundamental decisions in managing assets: what asset to be in, whether stocks, bonds or cash, in what proportion, when is it time to sell and take profits, and what signals to the manager that now is the time to change?

According to the Pension Fund’s website, the only `model’ that is used is an equity risk premium of 3 per cent. But this is a cod. This tells us that the NTMA has decided, looking back over recent history, that the risk in equities can be covered by a 3 per cent premium.

Obviously, a bull market such as we had in the 1990s would reduce the perceived risk of equities over bonds (risk-free government debt). This allows investors to be happy with excessive valuations on stocks, and therefore the average price earnings ratio on the S&P 500 at 50 times can seem like value for money.

But the recent falls in markets tells us that businesses are risky — considerably more risky than bonds. The disaster for our pension fund is that NTMA uses a backward-looking model that focuses on trends over the bull market. Therefore, your pension is priced for a bull market, not a bear market, and as a result is very risky.

This means that the fund is happy to buy extremely expensive stocks and still think they are good value. For example, the equity risk premium can vary from 0 to 8 per cent depending on what time horizon and the type of companies you are looking at — this is called the `beta’ in the jargon.

At 8 per cent, clearly the investor is pessimistic, and at 0 per cent the investor believes that there is no risk on business at all. Add to that the interest rate used to assess the opportunity cost, and we get the total risk in stocks or the real cost of equity.

The NTMA does not tell us whether it uses the two-month or the ten-year interest rate to discount. The upshot is that the cost of equity or the so-called equity risk premium can be anywhere from 0 to over 13 per cent.

If the premium is 13 per cent, any stock with a price/earnings ratio over eight times is expensive. If there is no premium then the price doesn’t matter. Whereas if the premium is 3 per cent, as the NTMA believes, our pension fund managers believe that any stock with a P/E of 32 times is still cheap. The long run P/E ratio for the US market is 13 times.

The point is that the NTMA is happy to buy stocks that are trading at more than twice their long-run price! This evidence answers the third, fourth and fifth questions: the reason the fund lost so much money is because the equity proportion of the fund is priced for a bull market which might not return for ten years.

To validate the excessively optimistic view of future profits, the NTMA must think the world economy is going to take off again, inflation will remain subdued and company profits will go through the roof.

Maybe they will — but that leads us to the next question: if the stock markets are going to rally, why the recent announcement that the NTMA has invested in a buyout fund? Why invest in a risky buyout fund if a rebound is around the corner?

If you think stocks are about to rise, the last thing you do is sponsor an action that will take the stock out of the market, thereby missing the upside.

Finally, the fund is fixed at 80 per cent equities, 20 per cent bonds. Lucky for us that the fund didn’t get the €6.1 billion Eircom money straight away in 1999, or we would have lost over 50 per cent of our pensions cash in the huge fall in the stock markets since March 2000.

This fund lost €760 million last year. It is down 24 per cent against its benchmark, but the problem is that its benchmark is priced for a huge recovery in the world economy.

Most believe this to be remote. It is high time the Minister for Finance reined in the empire at Treasury Buildings and began to ask some hard questions. Otherwise your money — €7.4 billion of it — will continue to gush down the drain.