24 June 2018

Pensions Paying High Management Fees For Nothing

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Famed baseball manager Sparky Anderson once said, “a baseball manager is a necessary evil.”

With America’s public pensions facing $1.4 trillion in cumulative shortfalls, pension managers may not even meet that standard. Indeed, Pew Charitable Trusts reports that public pension systems across the U.S. hold a mere $2.6 trillion in assets to cover total pension liabilities of $4 trillion.

New research underscores that America’s public pensions face a management crisis – not simply a funding crisis. Too many pension system managers pay above-average fees to investment managers in exchange for below average investment returns. This fundamental imbalance threatens the retirement security of tens of millions of teachers, police officers, and other public employees. Fortunately, the problem can be fixed.

To shed light on this matter, we conducted two studies through the auspices of the Maryland Public Policy Institute and the Johns Hopkins Carey Business School, respectively.

In the first study, we examined the 33 state pension funds that share a June 30 year-end. Despite these states paying an estimated $90 billion in fees to investment managers over the last decade, the median state produced an annualized return of 5.5 percent, about 0.9 percent less than an index fund’s 6.4 percent return with 60 percent in stocks and 40 percent in bonds.

The five states with the highest investment fee ratios earned a mere 4.3 percent in annualized returns over the past decade while the five states with the lowest investment fee ratios earned 5.5 percent annualized returns. Thus, Maryland, South Carolina Missouri, Maine, and Indiana paid more for less.

These investment returns suggest a huge opportunity cost in lost income that would have helped to shore up retiree savings. Active investment managers are not delivering adequate returns for pension funds.

When confronted with such evidence, state investment managers typically argue that they do not design their portfolios to beat a single benchmark. The high fee approach, they say, is designed to provide index–like returns while generating lower than index-like risk. But this notion, on its face, defies modern finance theory regarding the intersection of risk and return.

These facts beg the question: What benefits are policemen, teachers, and other state retirees getting in return for high fees paid on their behalf? According to our research, none at all.

Taxpayers may also wonder whether they will be asked in the near future to cover pension shortfalls created through no fault of their own.

To improve investment performance and contain fees, public pension managers should shift a majority of their assets into passive investment portfolios of public stocks and bonds to save, collectively, tens of billions of dollars annually.

Such a shift is not unprecedented. Nevada shifted its public employee pension system to a passive, indexed portfolio in 2016 and promptly outperformed its benchmark last fiscal year due in part to significant savings on fees. Pennsylvania’s Montgomery County shifted 90 percent of its pension assets to a passive, indexed portfolio in 2014. In the three years after that shift, the county consistently outperformed neighboring pension systems that were weighed down by hefty investment manager fees.

State pension fund performance has been a neglected area of public policy, in part, due to its quantitative nature, and in part due to the manner in which funds are frequently walled off from overt political interference. With yields moderating and fees ballooning relative to a composite index, state policymakers must ask themselves if distributing tens of billions to active investment managers at the expense of public workers and taxpayers is appropriate.

Our findings make clear states can do better. It is time to fix America’s underperforming state and municipal pension systems so workers and taxpayers receive a fair shake.

Click here for the original article from Washington Examiner.

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