The SIB, with assistance from the Retirement and Investment Office (RIO) staff, implements the investment strategies of the individual clients of the SIB based on the clients' investment policies, which contain their asset allocations. Investments are managed in pools, where feasible, to take advantage of cost efficiencies available to larger pools of money. The SIB externally manages all of its investments, and hires professional investment managers to manage strategies intended to best maximize returns for stated levels of risk within the client policies. The investment managers make the day-to-day decisions on which securities to buy or sell based on investment strategies they are hired to utilize. RIO staff acts as a "manager of managers" and coordinates the activities of the external investment managers, custodian bank and investment consultant. Please click here to view a diagram of the SIB investment program.
As of 6/30/22, the SIB has 12 statutory clients (as specified in NDCC 21-10-06) and 15 contracted clients. The largest include the Legacy Fund, Teachers' Fund for Retirement (TFFR), Public Employees Retirement System (PERS), Workforce Safety & Insurance Fund (WSI), and Budget Stabilization Fund. Other clients include the City of Grand Forks Pension Fund, City of Bismarck Employees and Police Pension Funds, and State Fire and Tornado Fund. For a complete list of funds, please refer to the SIB performance summary page which lists the various funds under the SIB and their net of fees performance history for various time periods. RIO, as well as the State of ND, operates on fiscal years (July 1 - June 30) rather than calendar years. When comparing investment returns it is important to understand the time periods reported.
According to NDCC 21-10-07, the SIB "shall apply the prudent investor rule in investing for funds under its supervision. The prudent investor rule means that in making investments the fiduciaries shall exercise the judgment and care, under the circumstances then prevailing, that an institutional investor of ordinary prudence, discretion, and intelligence exercises in the management of large investments entrusted to it, not in regard to speculation but in regard to the permanent disposition of funds, considering probable safety of capital as well as probable income."
Chapter 59-17 of the NDCC describes in more detail the prudent investor rule and standards of care. This chapter uses similar language to what is found in the American Law Institute's Restatement of the Law Third, Trusts: Prudent Investor Rule, 1992. The General Standard of Prudent Investment, under section 227 of this publication, includes the following:
The trustee is under a duty to the beneficiaries to invest and manage the funds of the trust as a prudent investor would, in light of the purposes, terms, distribution requirements, and other circumstances of the trust. This standard requires the exercise of reasonable care, skill, and caution, and is to be applied to investments not in isolation but in the context of the trust portfolio and as a part of an overall investment strategy, which should incorporate risk and return objectives reasonably suitable to the trust.
In making and implementing investment decisions, the trustee has a duty to diversify the investments of the trust unless, under the circumstances, it is prudent not to do so. In addition, the trustee must conform to fundamental fiduciary duties of loyalty and impartiality, act with prudence in deciding whether and how to delegate authority and in the selection and supervision of agents and incur only costs that are reasonable in amount and appropriate to the investment responsibilities of the trusteeship.
In general, the ND pension portfolios have performed at or slightly better than the median public pension funds around the nation, particularly during the past 10 years. This exhibit shows the TFFR and PERS funds' historical returns versus a peer group of currently over 200 public funds as tracked by investment consultant Callan LLC. This exhibit uses time periods ended June 30, 2022, the most recent fiscal year-end available for this database. The returns are all shown before the effect of investment management fees or "gross of fees" as this provides a more accurate comparison within the database of public funds.
One basis point is equal to 0.01% or one one-hundredth of a percent. As an example, if the fees on a fund are $200 and the total value of the fund is $100,000, the fees would be 200/100,000 or 0.20% which is 20 basis points.
As of June 30, 2022, the SIB utilized 44 professional investment firms that manage over 81 separate investment strategies.
For the fiscal year ended June 30, 2022, the SIB paid investment fees to professional investment firms for management, consulting and custodial bank services totaling 54 basis points (0.54% of total average market value).
A listing of investment firms and strategies and details of these fees can be found in the 2022 Annual Comprehensive Financial Report beginning on page 88 and 97, respectively.
The breakdown of fees by pool is as follows:
Pension Pool
For the fiscal year ended June 30, 2022 - 70 basis points (0.70% of average market value)
Over the past 30 years the fees for the pension pool averaged 60 basis points per year.
Insurance Pool
For the fiscal year ended June 30, 2022 - 24 basis points (0.24% of average market value)
Over the past 30 years the fees for the insurance pool averaged 28 basis points per year.
Legacy Fund
For the fiscal year ended June 30, 2022 - 52 basis points (0.52% of the average market value)
Although the Legacy Fund assets were first invested in 2012, fiscal year 2015 was the first year that the Legacy Fund was fully invested in a diversified asset allocation, therefore comparison of fees with prior years would be less meaningful. Over the past 8 years the fees for the Legacy Fund averaged 39 basis points per year.
Over the past 30 years, the asset allocations of the funds under the management of the SIB have become more diversified and incorporated asset classes with higher return expectations. These asset classes also have higher management fees. The expectation in selecting investment managers is that their returns will add value to the portfolio net of fees.
The SIB hired Callan LLC to conduct a fee analysis for all of the fees paid to investment managers for the fiscal year ended June 30, 2020. This review is generally done every two years. In 2022 we elected to not complete this analysis due to restructuring the investments with the intent to re-evaluate in 2023. The June 30, 2020, report can be found here.
Studies have shown that 90-95% of the total return of a portfolio is based on asset allocation. All client funds have unique asset allocations that are based on the underlying liabilities or cash flow needs of those funds. Which asset classes are performing better, what strategies are employed within each asset class and how much is allocated to each asset class determines the total performance of the fund. It is important to note that the asset allocation is not determined by the SIB or RIO but is set by the governing bodies of the client funds, such as the PERS or TFFR boards.
A benchmark is a standard against which the performance of an investment manager or asset class can be measured. A total fund policy benchmark is the total fund return that is expected based on the asset allocation of the fund and the asset class returns available in the market. Each investment client determines the target asset allocation for their fund, which is stated in the fund's investment policy statement. That target asset allocation specifies the percentage of the total portfolio that should be invested in each asset class. Each asset class is constructed based upon a benchmark portfolio as described by a specific market index or benchmark. Examples of these asset class benchmarks include the Russell 1000 for large cap U.S. stocks and the Bloomberg Aggregate for U.S. fixed income (bonds). The SIB and RIO staff assign each asset class a benchmark that represents the underlying risk and return expectations for that asset class and those benchmarks are weighted based on the target allocation for each asset class. Those weighted amounts are then added together to determine the total fund policy benchmark for a given time period.
Actuarial return assumptions are long-term in nature and are based, in part, on capital market projections obtained from multiple sources. These projections take into consideration long-term historical performance of the various asset classes as well as future long-term expectations in the markets. The return assumptions used by the pension funds (currently in the 7%-7.75% range) are reviewed on a regular basis, and the actuaries for the pension funds have determined the current return assumptions are reasonable.
All of the pension funds invested with the SIB are Defined Benefit Plans. This means that your pension benefits are determined by a formula defined as years of service × average salary × a multiplier. Fluctuations in the markets do not have a direct impact on your pension benefit; however, it may impact long-term funding available for the plans.
Asset allocation is set by each client based on the underlying liabilities or cash flow needs of a fund. Funds that have shorter term cash flow needs (i.e. Insurance Pool clients) generally will have higher allocations to less volatile asset classes such as fixed income and cash equivalents. When a fund is more long-term in nature (i.e. Pension Pool clients), higher allocations to asset classes with more volatility are appropriate to meet long-term return objectives. Because of this, each client sets its own asset allocation. It is important to note that the asset allocation is not determined by the SIB or RIO but is set by the governing bodies of the client funds.
Based on the asset allocations submitted by the individual clients, the SIB has created investment pools in which clients may participate. Each pool is made up of various investment managers hired to manage portfolios within those asset classes. RIO staff researches investment managers and brings recommendations to the full SIB for consideration. Representatives from the firm present to the full board, explaining their strategy and methods. A “Due Diligence” profile is completed for reference and fees are negotiated. All new investment management relationships are approved by the SIB.
Prior to contracting with a new investment manager, investment guidelines specific to the investment strategy are agreed upon and included as part of the contract documentation. Investment management firms are monitored both internally by their own compliance departments dedicated to ensuring that all contracted guidelines are followed and externally by RIO staff.
When a firm's internal compliance department determines that a situation has arisen that causes the portfolio to move outside of the investment guidelines, the investment manager will contact RIO staff and explain the situation. A decision is then made as to whether immediate action is necessary. All such instances are documented.
Additionally, RIO staff monitors the portfolios using both sophisticated software products and various reconciliation procedures. Portfolio performance data is collected monthly from the investment managers. The investment consultant, Callan LLC, also recalculates the performance of each portfolio based on the custodian bank data. RIO staff then compares the returns provided by the investment managers to Callan’s calculations to ensure that all data is reasonable. Investment returns are then compared to benchmarks chosen by the SIB and RIO staff to ensure that the portfolios are performing as expected. Large deviations from benchmarks can indicate that the portfolio is not being managed within original parameters. Investment managers meet with RIO staff at least annually to provide an update on their firms, discuss performance and provide overall economic analysis. If the SIB believes an investment manager is not meeting their contracted objectives, they may put them on a “watch list" by the SIB, prompting RIO staff to give that portfolio added scrutiny for a period of time, until the situation has improved or, when necessary, the contract is terminated.
The SIB and the individual client funds employ professional investment and actuary firms to assist them in ensuring the funds are managed appropriately. Asset/liability studies are performed, at a minimum, every 5 years by a third party firm. These studies take into account the underlying liabilities and total assets of the fund. These studies result in a range of options considered to be the optimum asset allocation for the fund based on risk and return assumptions. The client then selects what they feel is the best asset allocation for their fund.
The SIB also uses a custodian bank, The Northern Trust Company, whose job includes settlement of trades directed by the investment managers, record keeping of all investment transactions and safe-keeping of the invested assets. The custodian bank is audited annually, including a review of their internal controls and processes.
Independent financial audits are also performed annually on all of the investment management firms and any underlying funds or partnerships. The audit reports are made available to the RIO staff who review them for any issues that may be included in the reports.
An annual financial audit of the RIO office is also conducted (see following question). RIO’s auditors review the audits of the investment firms and custodian bank as well.
An investment consultant is also utilized for third party performance measurement of the investment manager accounts, to assist with investment manager searches and to provide education and other special projects for the board.
Under NDCC 54-10-01, the State Auditor must perform or provide for the financial audits of state agencies at least once every two years. To comply with that requirement, the State Auditor contracts with a public accounting firm to complete an annual financial audit of RIO. Contracts generally cover three fiscal years. RIO recently completed the second year of the current three-year contract with CliftonLarsonAllen (CLA) LLP. This is the fourth three-year contract awarded to CLA. The purpose of the financial audit is to determine whether RIO’s financial statements present fairly, in all material respects, the financial position of the fiduciary funds under its responsibility as of and for the year ended June 30 of each fiscal year. The most recent financial audit report of RIO can be found here.