When Wyoming got serious about saving and created the Permanent Mineral Trust Fund in 1974, nobody pictured what we have today: a Wall Street veteran, chief investment officer Patrick Fleming, weighing esoteric investments ranging from long-short hedge funds to master-limited partnerships.
Back then, the focus was simply on setting aside a portion of the taxes on minerals in an “inviolate” fund so that future generations would continue to benefit from Wyoming’s mineral wealth after it was gone. Equally important, the fund would provide steady income to the Legislature, tempering the boom-and-bust cash flows from Wyoming’s main revenue source — taxes on the minerals industry.
Stocks were in a deep bear market in 1974, and who needed them anyway? The constitutional amendment creating the PMTF talked only about the “interest” from Treasury bills going into the general fund. Ten-year T-bills back then yielded 7.5% returns. Today, they yield less than a tenth as much — just 0.6%.
Wyoming began dipping a toe in the stock market in the late 1990s. At first, legislators permitted only a quarter of assets to go into equities. The upper limit was raised to 55% during the 2000s, and increased to 70% in 2016 — though Wyoming has never come close to hitting that figure.
Today, the PMTF’s stated primary goals are what you’d expect from a fund with an unlimited time horizon: “Capital appreciation, total return and protection against inflation.” Sounds like stocks, right?
But the history of the PMTF is one of investment caution.
Less risk, less reward
In a story I wrote for Wyofile 11 years ago, I described Wyoming as being on the “conservative fringe” of the nation’s permanent funds — those designed to last in perpetuity. That remains true today, and it is probably the biggest single reason for the state’s long-term lagging returns.
When I interviewed former Treasurer Joe Meyer for that story near the darkest lows of the financial crisis, Wyoming’s short-term relative returns were looking great. But over the long term, Wyoming had lagged states like Alaska and New Mexico, which had between 75% and 85% of their permanent funds in equities.
Wyoming’s permanent funds had just 50% of assets in equities in 2009, with the rest in bonds and cash. The state was perfectly situated to take advantage of the sharp selloff in the stock market by moving toward a portfolio that looked more like Alaska or New Mexico — or nearly any other pension fund, foundation or endowment. Not only did Wyoming have cash at the ready, it had more pouring in every day, thanks to the ongoing strong energy market and the 1.5% severance tax that gets deposited into the PMTF.
Meyer, who died in 2012, was having none of it.
“If you get too greedy in this investment world, someone bites you,” Meyer said at the time. “This is a bad environment in which to say, ‘let’s take more risk.’”
In retrospect, it turned out to be a fabulous time to take on more risk — the S&P 500 earned nearly 15% per year over the next decade. Wyoming missed it early, and missed it pretty much throughout — including during the six years (2012-2018) that current Gov. Mark Gordon served as treasurer.
Hopes for a turnaround in performance were high in late 2015, when the state hired Fleming, a Wyoming native and Harvard-educated financier who once ran Barclay Investments. But Fleming worried that the bull market would run out of gas — he told the Legislature’s Select Committee on Financing and Investments in June 2016, during a discussion about asset allocation, that all asset classes looked expensive on a risk-adjusted basis, according to minutes of the meeting.
He and the State Loan and Investment Board, a group of the state’s five top elected officials that sets investment policy, positioned the state accordingly.
In June 2015, shortly before Fleming was hired, the PMTF had 23% of its assets in U.S. stocks. By June of last year, the share of it in U.S. equities had nearly been cut in half, to just 12.6%.
The market kept chugging along. The S&P 500’s annual return for the five years through June 2020 is 10.7%.
“Has the state been too conservative over the past 10 years? Hindsight would say yes,” Fleming said in an interview with WyoFile. “We should have been 100% in the Nasdaq. But that’s not how investments work. You don’t have that luxury.”
Some successes, many failures
Wyoming has definitely sacrificed earning power by holding too much in bonds and cash, but that doesn’t explain all of the weak returns. The performance of Wyoming’s two biggest permanent funds have lagged 3.3 percentage points per year behind the Vanguard Balanced Index Fund, which invests 60% in a broad U.S. stock index and 40% in U.S. bonds, over the decade ending last June.
During that time, Wyoming has had roughly 50% of its assets in equity-like investments. If Wyoming had devoted an extra 10% to equity-like investments (matching the Vanguard fund), performance would have improved by about 1.1% — making up only a third of the performance gap with that fund.
Reason No. 2 for the underperformance? The equity-like investments that Wyoming moved into, instead of sticking with the U.S. market, simply haven’t done as well.
The “endowment model,” popularized by David Swenson, the hugely successful manager of Yale University’s endowment, became gospel in the investment world about two decades ago — and Wyoming, like nearly all other managers of permanent funds, bought into the idea.
The model calls for extreme diversification, by moving assets out of the U.S. markets and into international stocks, private equity, hedge funds, real estate, and master-limited partnerships, among other asset classes. (Swenson also argues that an investor with a perpetual time horizon should avoid assets with low-expected returns, such as fixed income. Wyoming apparently missed that section.)
Former Treasurer Meyer described the shift at a New York investment conference in 2008. Wyoming had broadly diversified and moved into so-called alternative assets, he said, at the advice of its consultant, RVK, which predicted that “the overall risk profile would decrease and the return would increase.”
But what works for Yale hasn’t worked for Wyoming. Yale earned 11.1% per year on its endowment for the decade ending in June 2019 — 4 percentage points per year better than Wyoming.
Some of the new assets Wyoming moved into have succeeded, but many have not.
Wyoming’s $564-million investment in private equity has exceeded the return over time of the S&P, according to the state’s investment reports.
But Wyoming’s $752-million investment in hedge funds has been a disaster, earning just 1.68% per year from inception in 2007 through March 2020. That’s roughly what the state earned on its cash over the same period.
It’s also a fair bet — albeit not an easy-to-swallow one — that the state has made less from its 13 years of investing in hedge funds than it has paid out in fees to their managers. Wyoming invests in “fund of funds” that feature two layers of fees — and those can total as much as 3% per year plus 20% or more in performance fees, although fees have dropped in recent years due to weak returns. Fleming did not respond to an email seeking details about Wyoming’s hedge-fund fees.
The state’s decision to put more into international equities than the U.S. market — driven in part by higher dividends abroad, according to the state’s current Treasurer Curt Meier — has also been a flop for Wyoming. Wyoming’s international equity investments returned 6.79% over the 10 years ending in June 2019, higher than RVK’s “international equity custom index” but well under half the annual return that the state would have made in the S&P 500.
Fleming now personally handles much of the government fixed-income investing, and his returns have been solidly above benchmarks. But as the interest paid on safe bonds has withered to almost nothing, Wyoming has turned to some riskier bonds to generate income.
The biggest problem has been with emerging-market debt. That $709-million investment had, as of March 2020, lost 3.72% per year since the program’s inception in 2013.
“At some point we’ll revisit those and see whether we want to continue to stay in them,” Meier said. “We’re hoping to make that decision when we have a few beans in the pot rather than when we’re generating losses.”
A third major factor negatively affecting Wyoming’s returns is harder to pinpoint and explain, but makes it more challenging for Fleming and the treasurer’s office to allocate funds with true long-term vision. The Legislature depends on money from permanent investments for spending, but the investment funds themselves are considered “inviolate,” which means that the principal can never be spent.
To generate enough money to meet pay-out expectations, the treasurer’s office must routinely sell winners instead of losers. That may seem smart at first blush, but many investment experts counsel the opposite — selling your losers and riding your long-term winners.
And with below-average returns as a starting point, there aren’t that many winners to choose from. At the end of March 2020, thanks to the coronavirus-related market plunge, the price the state had paid for investments in the PMTF exceeded the market value of those investments by nearly $300-million. (The fund’s market value has since rebounded.)
Fortunes have been built over the past decade by riding big tech stocks like Microsoft, Facebook, Amazon, and Google for the long term — or by simply buying the S&P 500 index that those stocks now dominate. But buy-and-hold is not the Wyoming style, as Fleming noted in describing investment turnover in the treasurer’s office 2019 annual report.
“Over the past two years, we have changed 42 managers!” Fleming wrote.
Wyoming must churn investments because without regular realized gains, little income exists to distribute to the Legislature.
Michael Madden, an economist who served 12 years in the Wyoming House, including seven years as chairman of the House Revenue Committee, said that a few times he noticed “a bunch of capital gains taken at the last minute … in expectation of a tight budget year coming up. That kind of thing is fraught with risk — you’re sacrificing some earnings over the long run just to tide you through the short run.”
Don Richards, the top fiscal analyst in Wyoming’s Legislative Service Office, says the thinking in Cheyenne isn’t always that of a keen-eyed Ivy League endowment manager, contemplating how today’s investment will pay off 10 years down the road. Sometimes, he says, it’s more akin to an 80-year-old widow, with savings but no pension, trying to generate investment income any way she can.
“She needs to invest that money to pay rent and utilities, and to purchase food,” Richards says.
Does investing like an 80-year-old widow make sense for a permanent fund? What might work better? WyoFile will explore that in part three of the series.
This is part two of a four-part story package analyzing Wyoming’s investments and their impact on state spending. Read part one, Wyoming’s missed investment fund opportunities cost it billions.
Correction: This story has been corrected to clarify Patrick Fleming’s work history. The original version mistakenly stated that he had been the CEO of Barclays bank, not Barclay Investments.