Category Archives: Government workers and pensions

The Biggest Lie of All: Government Can Pay Its Pensions

State-local pensions are just one aspect of unsustainable government spending.

State-local pensions are just one aspect of unsustainable government spending.

Many people get infuriated by President Trump’s many inconsequential falsehoods — does it really matter how big his inaugural crowds were? — but they remain sanguine about the trillion-dollar untruths that our public pension system is built upon. The big lie that governments will make good on retirement promises to their employees is not merely mendacious but it is destructive. Millions of Americans have built their retirement plans around a fiction. And when the Ponzi scheme collapses, government workers won’t be the only ones to suffer.

In his latest column, George Will recites some of the more glaring examples of how the big lie is unraveling.

The Dallas police and fire fund recently sought a $1.1 billion transfusion, a sum roughly equal to the city’s entire general fund budget yet still not close to what is needed. Last year Illinois reduced its expected return on its teacher retirement fund portfolio from 7.5% annually to 7% (which is arguably still too optimistic), meaning that the state needs to add $400 million to $500 more to the fund — annually. Last September, the vice chair of the agency in charge of Oregon’s pension system wept when speaking about the state’s unfunded pension promises of $22 billion. Nationally, unfunded liabilities for teachers, not counting other government employees, amount to at least $500 billion.

And don’t get me started on the fact that the Medicare hospital trust fund is expected to run out in only 12 years and Social Security trust fund in 16 years, at which point payroll tax revenues will be insufficient to maintain full benefits… Or the fact that the pensions run by companies in the S&P 1500 Index were unfunded to the tune of $562 billion.

Some of the shortfall can be attributed to absurdly generous provisions of pension plans in particular states and localities, some to fiscal indiscipline by government at all levels, and some to the Fed’s seven years of near-zero interest-rate policies that have depressed returns on bond portfolios and juiced stock market gains that cannot possibly be replicated in the years ahead.

Will concludes with the salient point:

The problems of state and local pensions are cumulatively huge. The problems of Social Security and Medicare are each huge, but in 2016 neither candidate addressed them, and today’s White House chief of staff vows that the administration will not “meddle” with either program. Demography, however, is destiny for entitlements, so arithmetic will do the meddling.

Few elected officials are willing to deal with the issue that offers no immediate political reward. Here in Virginia, one of the few, House Speaker William J. Howell, R-Stafford, has announced that he will not seek re-election.

Thanks in part to Howell’s stewardship, Virginia’s budget, backed by a AAA bond rating, is in better shape than those of many other states. But the U.S. learned after the 2007 real estate crash what AAA bond ratings are worth when the economy shifts from normal conditions to crisis conditions. Boomergeddon is coming. The only question is when.

Thinking Sensibly about Virginia State Police Salaries

Lawmakers proposes big increase for Virginia State Police salaries.

Virginia State Police graduates. Lawmakers propose a big increase in starting salaries. Photo credit: InsideNova.com.

Virginia State Police troopers would receive a $7,000 pay raise — a 22.3% boost for starting salaries — under a budget proposal that also would provide a 3% pay raise for all state employees, reports the Richmond Times-Dispatch. The dramatic pay hike comes in response to deteriorating morale and a surge in state trooper departures.

Is such a big pay raise justified in the midst of a budget crunch in which lawmakers are forced to cut other programs?

Clearly, the state police have a massive problem. In November, the agency had 257 vacancies in a sworn force of 2,148, according to the Daily Press. Over the past few years, the state police averaged six departures monthly, reports the T-D. That number increased to 13 per month in last year and shot up to 22 in just the first 20 days of 2017.

By my back-of-the-envelope calculations, paying 2,150 officers an extra $7,000 each will cost the state about $15 million per year. That is a considerable sum. However, if the pay increase staunches the loss of manpower, it will be offset by a reduced training costs. The Times-Dispatch article notes that it costs the City of Richmond about $100,000 to get a recruit trained and on the street. Assuming that the cost to the state police is roughly comparable, and assuming the pay hike reduces the number of departures back to the pre-crisis norm of six per month, the state police will need to train 80 to 90 fewer troopers each year. That would represent a savings of $8 million to $9 million. (I have made several assumptions here, which undoubtedly can be refined, but you get the gist.)

Thus, while the $15 million departmental pay raise will not fully pay for itself through reduced turnover, the adjusted cost when taking training expenses into account will be considerably lower.

Are there other ways to offset the expense? Presumably, some state police functions are more critical than others, and some offer more law enforcement bang for the buck than others. Could the troopers be relieved of low value-added tasks that soak up manpower?

For example, lawmakers enacted a policy last year as part of a bipartisan compromise on gun control, in which state police conduct background checks at gun shows. Implementing that policy cost $300,000 annually to pay for three full-time civilian positions, as the Times-Dispatch reports here. In its first six months, the program resulted in only one person being denied the purchase of a weapon at 41 Virginia gun shows. The man was wanted for failing to appear before a grand jury in September. Was that one detention worth $300,000?

Six months may not be sufficient time to fairly judge the effectiveness of the program. But that’s the kind of question we need to be asking. Instead of stroking the state police a $15 million check, legislators should ask the top brass to enumerate all the tasks state troopers are called upon to perform. How much manpower do those jobs require? What value do they provide? Can we reduce the number of troopers on payroll without harming public safety?

It seems clear that we need to increase Virginia State Police salaries, and equally clear that the state will recoup some of that expense through reduced training expenditures. However, we should not assume that the only way to pay for higher salaries is to pump more money into the agency. Perhaps we can scale back tasks of marginal value. Unfortunately, I see no indication in the news coverage of this issue that anyone has even considered that alternative.

Budget Shortfalls Will Dog States for Decades

Projected state/local budget shortfalls as percentage of GDP absent policy changes.

Projected state/local budget shortfalls as percentage of GDP absent policy changes.

Over the next 44 years, state and local governments face chronic budget shortfalls driven by Medicaid spending, government employee health care costs, and underfunded pensions, warns the U.S. Government Accountability Office (GAO) in a report issued earlier this month.

“Absent any intervention or policy changes, state and local governments are facing, and will continue to face, a gap between receipts and expenditures in coming years,” states the report. Closing that gap would require cutting spending by 3.3%, increasing revenues by a like amount, or implementing some combination of the two, stated the report.

Budgets eventually will come back into balance around 2060 when the demographic bulge of the Baby Boomer population passes from the scene, reducing pressure on Medicaid and pensions. However, fiscal pressures could become acute long before then.

The increase in health care expenditures will be relentless, drip-drip-drip year after year, driven not only by the cost of delivering care but the cost of providing care to an aging poor population. Unfunded pension liabilities are easier to sweep under the rug in the short-term but could become a crisis as pension funds burn through their accumulated assets.

States the GAO report:

While most state and local government pension plans have assets sufficient to cover benefit payments to retirees for a decade or more, plans have experienced a growing gap between assets and liabilities over the longer term. Our simulations suggest that state and local governments will need to increase their pension contributions, absent any changes to benefits or employee contributions in the future. Alternatively, state and local governments may need to take steps to manage their pension obligations by reducing benefits or increasing employees’ contributions.

Bacon’s bottom line: Analyzing the state/local government sector as a whole, the GAO report did not differentiate between the states. Clearly, some states will experience more severe budget shortfalls than others. My impression is that Virginia is better off than the average but that we still face a reckoning.

Virginia’s exposure to higher Medicaid costs should be less than the national average because Republican legislators blocked Governor Terry McAuliffe’s bid to expand the program as encouraged by the Affordable Care Act. Long-term, Virginia would have been responsible for funding 10% of the expansion. There is a trade-off, of course. The Old Dominion is foregoing an injection of federal dollars to fund medical coverage for the near-poor.

Also, Virginia did reform its state/local government pension plans under the McDonnell administration, keeping the old “defined benefit” plan for older state employees but implementing a hybrid defined benefit/defined contribution plan for new employees. State funding to the Virginia Retirement System also assumes a 7% annual return on VRS’s investment portfolio, less than the 7.5% assumed by other states. The actual return likely will be lower, I have argued, requiring everyone to pony up more cash than expected. Regardless, Virginia’s adjustment to economic reality will be less traumatic than that of many other states.

Meanwhile, House Speaker William J. Howell, R-Stafford, has been exploring a second round of reform at VRS. The state could save millions of dollars a year by paying less to outside money managers. Also, Howell has backed a 401(k)-like defined contribution plan for new employees, which shifts the risk of under-performing stock and bond indices from the state to employees.

Press reports have suggested that Howell is having difficulty getting traction. Perhaps Virginia should emulate the Social Security and Medicare Trust Fund trustees who annually publish projections of how long the Social Security and Medicare trust funds will last before the money runs out. It would be useful to know (1) how long the money in the Virginia Retirement System will last before the coffers run dry, (2) how much it will cost the state at that point to restore benefits to promised levels. Such knowledge might focus Virginians’ attention on the need to act sooner rather than later.

(Hat tip: Tim Wise.)

Tackling Virginia’s Hidden Budget Deficit

Like a black hole, Virginia's hidden budget deficit is invisible but immense.

Like a black hole, Virginia’s hidden budget deficit is invisible but immense.

Restoring a pay raise for state employees outranks pension reform in the recommendations of the Commission on Employee Retirement Security and Pension reform. The legislative commission voted yesterday to prioritize a 3% pay raise for state employees that Governor Terry McAuliffe has proposed putting on hold in the face of $1.5 billion revenue shortfall.

House Speaker William J. Howell, R-Stafford, who chaired the commission, “struggled” to keep the panel’s focus on his own priority, creation of an optional 401(k)-style retirement plan for newly hired state employees, reports Michael Martz with the Richmond Times-Dispatch. Under the current arrangement, new employees have a hybrid defined benefit/defined contribution plan.

Virginia faces a long-term unfunded liability of $23 billion for the $70 billion Virginia Retirement System (VRS). The liability mounted in the past two fiscal years as the VRS fell short of an assumed 7% investment, although the VRS reported Monday that investment returns the past 12 months, spurred by a booming stock market, achieved 8.7%.

While pushing for the pay raise, the commission gave a watered-down endorsement of Howell’s priority, recommending that the General Assembly “consider” creating a defined contribution plan.

Bacon’s bottom line: In theory, the Virginia Constitution requires the Commonwealth of Virginia to balance its budget every year. The trick is, what constitutes a “balanced” budget? Accruing $23 billion (and that’s probably under-stating the problem) in unfunded pension liabilities technically does not count as “deficit spending.” Neither does short-changing the compensation of state employees, which creates major issues for recruiting and retaining a competent workforce when long-term Baby Boomer employees retire. But these shortfalls are only one step removed from a budget deficit. They pile up future obligations just as the state would if, say, it deferred maintenance on roads and highways year after year.

Legislators face hard, hard choices in a world in which sluggish economic growth and expanding Medicaid enrollment crowd out other spending.  Short of raising taxes, which would create a new set of problems, Virginia has no choice but to radically re-think government from stem to stern.

First principle: State and local governments should focus exclusively on core functions, excel at those functions, and abandon the rest. Corollary of the first principle: It takes good employees to achieve excellence. Second corollary: It takes competitive pay and benefits to recruit and retain good employees.

Second principle: State and local government should not rack up a budget deficit disguised as unfunded future obligations that will bedevil the next generation.

Govern accordingly.

Paying University Executives for Performance

Michael Rao, Virginia's highest-paid state employee

Michael Rao, Virginia’s highest-paid state employee

The Richmond Times-Dispatch published its annual ranking of highest-paid state employees Sunday and, no surprise, university presidents and Virginia Retirement System (VRS) executives dominate the list.

I’m of two minds. On the one hand, if you want the best people running your universities and your pension funds, you have to pay them competitive salaries. Basically, you get what you pay for. Don’t expect exceptional results if you hire mediocre leaders.

The compensation of top VRS executives is largely tied to investment results. Investment mangers get rewarded if they deliver superior returns, a metric that is directly aligned with the interest of Virginia citizens. I have no problem with that. On the other hand, what do Virginia’s public university presidents get rewarded for? I know one thing: not for restraining tuition hikes.

Let’s take a look at Virginia Commonwealth University’s president, Michael P. Rao, the highest-paid state employee last fiscal year. According to T-D calculations, he earned $901,000 in fiscal 2016.

As befitting a public employee, Rao earned a base salary of $183,000. That’s a modest sum for a man running an organization with operating expenses of roughly $1 billion a year, so it’s no surprise that the Board of Visitors supplemented his base salary with:

  • $191,500 in deferred compensation
  • $72,000 housing allowance
  • $50,000 to cover personal expenses relating to his role as president
  • $7,000 for tax preparation
  • $5,000 for disability insurance from his previous contract
  • $2,160 for wireless communications
  • $42,500 for an automobile provided by VCU (and not included in the salary calculation)

Plus, he got paid a $50,000 bonus paid for meeting performance goals in 2014-2016. The T-D noted that the board will meet next week to evaluate Rao’s last-year performance and a new set of measurements to reflect the university’s objectives this year, but did not say what the performance goals were.

The VCU president’s page refers vaguely to three “themes” relating to the universty’s vision and goals: (1)  “provide all students with high-quality learning/living experiences;” (2) “attain distinction as a fully integrated urban, public research university;” and (3) “become a national model for community engagement and regional impact.”

What metrics would demonstrate progress toward achieving those goals? I’m hard-pressed to imagine.

Suggestion to the T-D: Next year, it might be worthwhile to find out exactly what performance metrics were used to calculate Rao’s bonus. As a matter of fact, it would be useful to obtain that information for every public university president. There could be no clearer indicator of university boards’ top priorities. I would be very much surprised to find that “holding the line on tuition charges” is among them.

Quantitative Squeezing

Bond yields have declined steadily for thirty years. As long-term and mid-term bonds expire and get rolled over at lower yields, pension funds generate much lower returns on their bonds portfolios. State and local funding for public pension funds has not kept pace with this market reality. Graphic credit: Wall Street Journal.

Bond yields have declined steadily for thirty years. As bonds expire and get rolled over at lower yields, pension funds have been generating lower returns on their portfolios. State and local funding for public pension funds has not kept pace with this market reality. Graphic credit: Wall Street Journal.

It’s nice to see mainstream media highlighting an issue that I’ve been hammering here at Bacon’s Rebellion for a couple of years now. A front-page Wall Street Journal article discusses how the zero-interest rate policies of central banks around the world are crippling returns on pension portfolios, making it difficult for nations and municipalities to meet their obligations.

Among the numbers cited in the article… Global pensions on average put roughly 30% of their assets in bonds. Investment-grade bonds that once yielded 7.5% a year now deliver almost no income at all. Low rates helped pull down assets of the world’s 300 largest pension funds by $530 billion in 2015.

The California Public Employees’ Retirement System (CALPERS) posted a 0.6% return in fiscal 2016. Its investment consultant, reports the Journal, recently estimated that annual returns will be closer to 6% over the next decade, shy of its 7.5% annual target.

If CALPERS is ready to admit that investment returns will remain depressed over the decade ahead, maybe it’s time for the Virginia Retirement System to do the same. The VRS assumes a 7% annual return on its portfolio — not as divorced from reality as many states, but significantly more than justified by bond returns. The problem, of course, is that acknowledging reality will expand Virginia’s public pension unfunded liabilities by billions of dollars — and nobody knows where the money will come from. So, we’ll pretend the problem doesn’t exist… until it becomes a crisis.

$6 Million Bonus for VRS Staff — Justified or Not?

piles_o_cashby James A. Bacon

The Virginia Retirement System (VRS) has awarded $6 million in incentive pay to its internal investment team, raising the issue of whether the Commonwealth of Virginia is creating a caste system of “haves” and “have nots” in its workforce.

The VRS Board of Trustees approved the incentives yesterday, reports the Richmond Times-Dispatch, even though the VRS portfolio generated a return on investment of only 1.9% in fiscal 2016, far short of the 7% long-term goal. The bonus was justified, VRS officials contended, because the pension fund’s internal investment team out-performed the 1.3% return of its benchmark.

As Chief Investment Officer Ronald D. Schmitz explained, the internal team has generated an average of $289 million a year over the benchmark over the past decade, while also saving $26 million in fees to Wall Street investment managers. “A $6 million bonus versus a $300 million gain seems like a pretty fair gain to me.”

However, as the T-D’s Michael Martz observes:

The timing of the investment awards also is awkward, as the state grapples with a projected $1.48 billion revenue shortfall that already has wiped out scheduled raises for state employees, college faculty and school teachers, and state-supported local employees, including sheriff’s deputies.

“State agencies and institutions that charge tuition, sell lottery tickets, license businesses and manage employee pension plans are free to use those funds to give employee pay raises,” said R. Ronald Jordan, executive director of the Virginia Governmental Employees Association. …

“Treating employees based on agency revenue source has resulted in tremendous pay disparity and a system of agency “haves” and “have nots.”

Bacon’s bottom line: Jordan has a point, and it’s understandable why state employees would be demoralized. But what’s the solution? Should we stop rewarding VRS investment professionals for superior performance, a standard practice in the financial services industry? If the internal team can save tens of millions of dollars, doesn’t everyone come out ahead? The alternatives — letting top performers get snatched up by the competition, or settling for sub-par performance by highly paid Wall Street money managers — will only increase the financial stress on the Commonwealth and make it more difficult to raise employee salaries in the future.

I made a similar argument yesterday: Paying top dollar to hire top talent to run the state’s IT services will lead to better decisions that save the state money. State government needs to reward the people in critical functions who do superior work. The alternative is to be “fair” but broke.

Long-Term VRS Performance Not Looking So Good

by James A. Bacon

Governor Terry McAuliffe announced Thursday that Virginia faces a budget shortfall of roughly $1.5 billion in the current biennial budget. That’s a big short-term problem, one of the worst in recent Virginia history — and possibly the worst ever during a period of economic expansion.

However, the long-term picture doesn’t look any better. The prime culprit is unfunded liabilities in an era of chronic low interest rates.

The official actuarial estimate is that the Virginia Retirement System faces a liability of $22.6 billion. As I have noted on many an occasion recently, that assumes that the VRS manages to generate an average 7% return on its $68 billion investment portfolio for the indefinite future. A year ago that didn’t look like such an outrageous proposition. Here’s what VRS’s portfolio performance looked like compared to national benchmarks:

VRS_returns_2015

Here’s what the VRS’s most recent (June 2016) comparisons look like:

VRS_annualized_return

What a difference a year makes. The average 10-year return is significantly below the assumed 7% figure. The five- and three-year returns do look better, but are they a better representation of likely long-term performance than the 10-year average?

The answer largely depends on which base year we choose to make our comparisons. The three- and five-year comparisons cover periods that were pure bull markets for stocks and bonds. The base year for the 10-year comparison was 2006… just before the Great Recession… thus including a major bear market correction as well as the subsequent bull market. I would argue that the 10-year comparison is more useful because it measures performance from the peak of the early-2ooos business cycle to the peak (or near-peak) of the current business cycle.

If we accept that logic, VRS is not achieving the portfolio growth it needs to meet its own 7% return-on-investment standard. While we can applaud VRS for out-performing its peer pension funds, we should not delude ourselves that 7% growth is a reasonable assumption. In all likelihood, VRS will fall short, and Virginia taxpayers will be called upon to make up the difference.

Perhaps my view is excessively pessimistic, but it is not implausible. The very least we can do is to conduct a sensitivity analysis. If VRS returns are only 5.6% over the next 10 years, then unfunded liabilities will increase to what level? $40 billion? $50 billion? We need to know our potential exposure should things not work out as we hope. It’s better to know this now, when we can plan for it, than get bushwacked by reality a decade from now.

Stick It to the Hedge Fund Managers!

VRS_management_fees2
by James A. Bacon

One of the voices urging reform of the Virginia Retirement System (VRS) is a semi-retired University of Virginia economics professor, Edwin T. Burton III, who served 18 years on the board. He argues that the VRS pays too much in management fees to outside investment firms that pursue labor-intensive strategies and should rely on low-overhead funds that index stock and bond markets.

In fiscal 2016, the VRS generated a 1.9% return but lagged the 3.99% return on the S&P 500. The year before, the VRS generated a 4.7% return compared to a 7.4% return for the S&P. “We haven’t come close” to the 7% rate of return assumed by the VRS in reaching its calculation of $22.6 billion in unfunded liabilities, he told Michael Martz with the Richmond Times-Dispatch.

Getting a higher rate of return is the best way to boost the financial health of the state retirement fund. Of course, that’s easier said than done. Everyone would like to boost returns on their financial investments, but very few investment managers have outperformed the market consistently. While pension funds can tinker with their portfolios, shifting funds between stocks, bonds, real estate, private equity and hedge funds, often chasing yesterday’s hot categories, they can’t control their returns. But they can control how much they pay outsiders to generate those returns.

As it happens, the VRS paid $362 million in management fees in 2015, according to its 2015 Comprehensive Annual Financial Report. (The 2016 report is not yet online.) That sum is divvied up between ten major investment categories such as U.S. and foreign equities, fixed-income, real estate, hedge funds and other alternative investments.

Hedge fund managers stick out like a sore thumb — they collected $87 million in management fees. Hedge funds delivered outstanding returns for many years, which justified their sky-high management fees, but they have stubbed their toes in recent years. With some 10,000 funds playing in the sandbox, typically betting on movements of currencies and commodities, competition has squeezed industry profit margins to nothing. After years of sub-par returns, there is no justification for the overly generous fee structure.

VRS also paid exceptionally high fees to “alternative investment” managers and for its “strategic opportunities portfolio.” Taxpayers might wonder if those fees are worth the returns they generate.

Remarkably, the VRS staff, which manages one third of the portfolio, cost one-tenth that of the hedge-fund and alternative-investment managers.  If the entire portfolio were managed that efficiently, management fees would have cost only $81 million in 2015 — a savings of about $280 million! Over the years, that could amount to billions of dollars.

So, why don’t we fire the hedge fund managers?

It gets complicated. First of all, you don’t mind paying higher fees to managers who outperform the market averages. Unfortunately, the VRS annual report doesn’t tell us the performance of its individual funds, and even its discussion of investment categories (stocks, fixed-income, hedge funds) doesn’t match up with the categories listed in its table of management fees. So, there’s no way the public can tell if the management-fee differentials are worth it or not.

Second, you shouldn’t judge a fund manager based on one year’s performance. Even the best can have a bad  year. What most interests me is the internal VRS performance. Does its track record over the years equal that of other fund managers? If so, why we paying the other fund managers?

Third, there is a benefit to diversifying a portfolio. The idea is to limit exposure to wide swings in any single investment category. Strong performance in one category offsets weak performance in another. A pension portfolio that invested only in stocks and bonds would be distressingly volatile.

Still, Professor Burton has a point. The VRS may be paying way more than it needs to. Saving $280 million a year won’t bail out a pension fund with $22.6 billion in unfunded liabilities (probably an optimistic assessment), but it sure would help, creating less pain for Virginia’s public-employee pensioners and taxpayers. The idea is definitely worth a closer look.

Digging into Rate-of-Return Assumptions

vrs_portfolio

by James A. Bacon

House Speaker William J. Howell is rightfully concerned about the long-term health of the Virginia Retirement System. The pension system’s own actuary estimated a year ago that the $68 billion retirement system has unfunded liabilities of $22.6 billion.

On Sunday, the Richmond Times-Dispatch’s Michael Martz described the debate over restructuring the VRS from a defined-benefits system to a defined-contribution system. Today, Martz reports how Howell is questioning the outsized fees paid to outside fund managers, who handle two-thirds of the system’s assets.

“My biggest concern is the unfunded liability and the fact that it’s just going to grow,” Howell said.

Howell has every reason to be concerned. Unfunded liabilities might turn out to be far bigger than the actuary’s estimate. As I have observed many times, the liability is based upon an assumed 7% annual rate of return on the $68 billion portfolio. If the system under-performs expectations, as the VRS has done the past two years, the unfunded liability can grow by tens of billions of dollars. Writes Martz:

For Howell and other lawmakers on the [Virginia Commission on Retirement Security & Pension Reform], however, the retirement system’s recent investment performance has raised questions about whether the 7% assumed rate of return is too optimistic for the longer term, especially with interest rates keeping bond yields low for the foreseeable future. …

The 7 percent return, lowered by the VRS board from 7.5 percent in 2010 is among the lowest in the country for public pension funds, said Katie Selenski, state policy director for the Pew retirement initiative. “At 7 percent, you’re in a good, prudent position.”

Prudent? Not really. The pie chart above shows VRS’s portfolio allocation. Some 17.6% consists of fixed income assets. Barring some bizarre experiment with negative interest rates in the U.S., there is no way in a zero interest-rate environment that these assets can generate a 7% return. Another 39.8% of the portfolio consists of equities. Insofar as the bull market in stocks over the past 30 years has been driven by lower interest rates and an expansion of earnings multiples, there is no way to replicate the stock gains of the past ten years. Indeed, earnings and earnings quality of stocks are deteriorating, not a good sign for near-term price performance. Meanwhile, the performance of hedge funds nationally has been dismal of late. There is no rabbit to pull out of the magic hat of alternative investments.

For another view on the outlook for long-term portfolio performance, it is instructive to turn to the University of Virginia, which, whatever one might say about the Board of Visitors’ strategic priorities, one must credit with doing an excellent job of managing its endowment. The 10-year return of the University of Virginia Investment Management Company (UVIMCO) has been 10.1 %, according to its 2014-2015 annual report. That compares to 5.8% ten-year performance calculated by the VRS in 2014-2105.

How much do UVa’s masters of the universe think they can earn on their portfolio looking forward? As best as I can tell from perusing UVIMCO’s annual report, they don’t say. UVIMCO doesn’t report that assumption because it isn’t relevant:  Although UVIMCO does have unfunded commitments, it is not a pension fund in which shortfalls must be made up by taxpayers.

Still, it is possible to get a sense of UVa’s expectations from comments made by university officials that they expect the controversial $2.2 billion Strategic Investment Fund to throw off $100 million a year to pay for programs to advance the university’s strategic goals. University officials have not explained what rate-of-return assumptions they are using. But a simple calculation reveals that $100 million is only 4.5% of $2.2 billion.

From that, one can draw one of two conclusions. Either UVa’s investment mavens are assuming a much lower rate of return than the VRS, or they expect a higher-than-4.5% rate of return but plan to retain a substantial fraction of the earnings, presumably in order to grow the size of the portfolio.

It appears that the second conclusion is true. Here’s what the UVIMCO annual report says: “Each year a portion of the endowment value is paid out to support the fund’s purpose, and any earnings in excess of this distribution help build the fund’s market value over time. In this way, an endowment fund grows and provides support for its designated purpose in perpetuity.”

For legislators digging into UVa’s controversial Strategic Investment Fund, which is managed by UVIMCO, it would be interesting to know what rate-of-return the university is assuming for its endowment and what percentage it figures on spending and what percentage it figures on retaining. The numbers should be equally interesting to Speaker Howell. It would send out a flashing yellow caution signal if the UVIMCO’s assumption about of future performance was more conservative than that of the VRS.