Want to avoid tax hikes? Vote ‘yes’ on investment item

OUR LEGISLATORS have promised more than they could afford to state retirees, to the tune of $9 billion. They could scale back the promises for future employees, but federal rules require us to keep the promises already made, which leaves two options for closing that gap: Taxpayers can kick in more, or we can get better returns on our retirement system’s $26 billion portfolio.

In theory, the state could make more off our investments now, by buying stocks with a higher rate of return. But the cost of a higher return on an individual stock or class of stocks is a higher risk. So that strategy subjects the state to unnecessary risk.

There’s a way around this equation, and it’s pretty simple. You can increase your rate of return (up to a point) without increasing risk by diversifying your investments. This isn’t some kooky, new-fangled idea; it’s the basis of modern portfolio theory, which revolutionized investment strategy — in the 1950s.

State retirement systems may be in the best position to take advantage of this, because they don’t need immediate access to much of their money; some won’t be paid out for 70 years. So most states responded to the investment revolution by dipping toes into the stock market. But South Carolina’s constitution prohibited investing state funds in private companies, the remnant of a Reconstruction-era railroad swindle. It was 1996 before we lifted that ban, and then we limited investments to U.S. stocks traded on major U.S. exchanges.

That was too conservative even a decade ago; today it’s conservative to the point of being risky. But since the restriction is in the constitution, it can only be removed through a constitutional amendment. That’s what Amendment 3A on next week’s ballot would do. (Amendment 3B eliminates a defunct advisory investment panel, which is also a good idea but less vital.)

The amendment allows retirement funds to be invested in foreign companies, including BMW, Honda and other manufacturers that fuel our state’s economy. If you have a 401(K), chances are some of your own retirement funds are invested overseas. It also allows investments in non-publicly traded assets, from venture capital funds to small start-ups or even well-established companies about to go public. Think Microsoft in its early days, Krispy Kreme right before it was listed.

Investing entirely in foreign stocks is risky — but so is investing entirely in U.S. stocks, as we do now. The smart money’s on both, because U.S. and foreign markets are “imperfectly correlated”: International stocks often do well when U.S. stocks do poorly, and vice versa. In the past five years, for example, returns on international stocks were two to three times as high.

Changing the constitution won’t force the state to do anything. Investment decisions are made by a panel of five private investment experts who are appointed individually by the governor and the other members of the Budget and Control Board; that board or the Legislature can rein in the commission if it ever wants to.

What the amendment does is give the state more tools to design an investment strategy that can produce better returns at a lower risk. That takes the pressure off taxpayers to make up for blips in the pension system, and it helps protect the state’s credit rating, which allows us to borrow money at better rates. This long-overdue change deserves an enthusiastic “yes” vote.

Go to thestate.com and select “Opinion” to read previous endorsements and election commentary.