Pennsylvania Blew $600 Million on Pension Fund Managers and Doesn't Have Much to Show for It

Like paying "LeBron James' free agent salary and getting me," says state auditor


John Greim John Greim Photography/Newscom

When a professional sports team spends big bucks on a superstar who is supposed to take them to the top of their league, fans tend to get pretty upset when the performance doesn't match the promise.

Taxpayers and pensioners in Pennsylvania should feel the same sort of expectations for—and disappointment with—the highly paid men and women managing the retirement funds for state employees. At least that's what Auditor General Eugene DePasquale thinks.

Okay, bear with me here. No white collar worker at the state's Public School Employees Retirement System (or PSERS, the larger of Pennsylvania's two public pension funds) is going to generate the same excitement or angst as the performance of the Philadelphia Phillies' Ryan Howard—perhaps the poster boy, at least in Pennsylvania, for an overpaid, underperforming professional athlete.

But DePasquale is going for the analogy anyway. And it actually works.

"Imagine paying Kevin Durant's free agent salary or LeBron James' free agent salary, and getting me showing up at training camp," he said, referring to two of the National Basketball Association's best and highest-paid players–each makes more than $20 million per year playing for the Golden State Warriors and Cleveland Cavaliers, respectively.

"I mean, the fans would rightfully be outraged," he said.

Minus the outrages, that's basically what has happened in Pennsylvania. During fiscal year 2015, PSERS and the smaller State Employees Retirement System reported paying a combined $610 million to private investment managers to manage the $78 billion in assets held by the two pension funds.

For the record: that's about 26 times more than LeBron James made last year.

Despite that, neither fund is doing very well. For the same fiscal year, PSERS posted a positive return of 3.04 percent while SERS earned just 0.4 percent. During the same period—from July 1, 2014, through June 30, 2015—the Dow Jones Industrial Average climbed by better than 6.5 percent, and other stock market indices performed similarly well.

Why pay all that money to underperform the market, asks DePasquale.

"We have to examine whether that is worthy of taxpayer and pensioners' money," he said last week. "When we're paying that tens of millions and they're not even beating a conservative stock index fund, we have to question what are we getting for that money."

All this should matter to taxpayers—yes, even more than the performance of professional baseball or basketball players—because of how public sector pension plans work. They're funded with a combination of tax dollars, contributions from public sector employees, and the returns from investments.

But the contributions from public workers are locked in place by contracts, so if the investment returns come up short of expectations—each fund has its own "target" but PSERS assumes a 7.5 percent annual return—taxpayers have to make up the shortfall. Already, taxpayers in Pennsylvania are staring at the prospect of paying off more than $60 billion in debt the two pension funds have piled up.

For their part, the two pension funds point out they've taken steps to reduce fees to outside investment firms in recent years. Fees paid by PSERS have declined from $588 million in 2013 to $455 million in 2015, according to the fund's annual report, while SERS has seen a similar decrease.

Pennsylvania's pension funds aren't the only ones paying investment managers for less-than-stellar returns. A recent study from the Maryland Public Policy Institute found 33 states spent more than $6 billion on pension fund management fees in 2015. States that spent more did not outperform those who spent less, and pension funds using professional managers did not outperform stock market averages over a five year period, the study found.

Last month, DePasquale's office launched a wide-ranging audit of the state's two pension systems, including a look at why and how the state is paying so much to private investors.

The audit coincides with the arrest of Barbara Hafer, a former Pennsylvania Treasurer who stands accused of lying to the FBI and the IRS about $700,000 in consultation fees paid by state taxpayers to Richard Ireland, who prosecutors allege made millions by helping secure state contracts for private investment managers while simultaneously contributing six-figures to Hafer's campaign accounts over a period of several years.

Both Hafer and Ireland deny the charges and have pled not guilty.

DePasquale said the indictment did not prompt the audit, which was already in the works before those charges were announced. But he welcomes the extra attention that will be paid to his usually staid work.

Even if the events aren't connected, the Hafer indictment—along with the previous indictment of another state treasure, Rob McCord, on similar charges in 2014—demonstrates how easily these lucrative state investment contracts can be handed out as bits of political patronage.

Fighting cronyism and reducing fees that shrink pension funds' returns are good steps. If the funds can make better returns by using indexed investments—those that are tied to the performance of the entire stock market, or a segment of it, and require less management—they should do that.

Still, as long as the state is handling such massive piles of money on behalf of public employees, there will have to be someone to manage it. Reformers in Harrisburg and elsewhere around the country have argued that privatizing state retirement accounts are the best way to avoid heaping those costs on taxpayers.

That would leave workers in charge of their own investments, and would get taxpayers off the hook. Any fees to investment managers would be paid because workers decided to invest their retirement cash in a certain way, not because the state decided to decide for everyone.

To go back to the sports analogy, it would give every fan a say in whether their favorite team signed the next high-priced free agent—rather than making them watch helplessly for years while an overpaid, underperforming star drags their team down toward mediocrity.