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.

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  1. Underperforming the market is okay if they want a different risk profile than the market.

    But honestly, just throw X% in a market index fund and (100-X)% in an index bond fund and be done with it. Overhead costs should be virtually nothing.

    1. Overhead costs should be virtually nothing.

      This. The investment managers are screwing them and should be compensated based on rate of return.

      Wherever there are such enormous piles of cash, there’s going to be corruption.

      That said, part of the reason their returns are so low is that the Fed is holding interest rates down and bond returns are horrible. I imagine Pennsylvania requires a large portion of the funds to be in bonds.

      1. 68 billion is too big a fund to beat the market. At best you can get market average. How are you going to invest 68b in a promising start-up? The answer, you can’t.

        1. Call Bernie Madoff, I hear he’s got some good ideas.

        2. While he continues to do it, even Buffett says he can’t beat the market forever as large as BRK is.

          1. I think beats the market by purchasing distressed companies at a discount. He has leeway that these guys probably don’t.

            1. His problem is, that he can’t go after small distressed companies.

              A $100MM company isnt worth his time, despite the potential ROR.

        3. But there’s no need to beat the market. Just be the market (invest in Total Stock/Bond Market Funds) and go to sleep for 50 years. The total management cost should be like $10 vs. $610M, and fees will be a rounding error. I think the Vanguard versions of these funds charge somewhere in the .15% range. Market returns would be good enough, especially if they adjusted their expected return to something reasonable. A 7.5% real return is just too high.

          1. I’m in vanguards admiral fund (VFIAX). It’s .1.

          2. .05%. My memory, she’s not so good.

          3. As someone above said $68b is too large a sum of money. Even investing less than .1% of that it is large enough to move the markets, which is not as good a thing as it may sound like. Also you have to be diversified enough that the pension fund does not end up owning the investment outright. It’s not to difficult to outperform Warren Buffet if you know what you are doing, and when you are investing small sums of money. It is much harder to beat the market when you are dealing with Billions of dollars.

  2. Anyone know if Penn has a guaranteed rate of return on their pension funds that the taxpayer has to make up if it under performs? It stings a bit more paying $600 million if you also have to cover the poor performance.

    1. Yes, it says that in the article.

    2. Yes, it says that in the article.

      1. Thanks, I missed that.

  3. I am unclear on why it costs more to invest $68B than to invest $6B.

    I get that there are realities to investing giant monies that don’t apply to my 401k, but I’d think you should be able to manage any amount of money for $100M.

    And as noted above, there should be consideration for the risk profile. But if the target is 7.5%, that doesn’t scream “low risk profile” to me.

    I’d be more interested in knowing how they did in 2008. Did they avoid the downturn in a meaningful way?

  4. each fund has its own “target” but PSERS assumes a 7.5 percent annual return

    Oh, ho ho ho. Ha ha ha. It is to laugh.

    1. It is doable…but the risk profile needed to make that happen is, well, aggressive.

      1. Given that they probably have to have @ half their portfolio in bonds, and a big chunk of that in government bonds (typical for pension funds), 7.5% YOY is impossible. That means their equities have to return, call it 14% YOY. Can’t be done for a big chunk of money over a long period.

        The overstated rate of return allows them to give phat pension packages to pubsecs, and keep this year’s hit on the taxpayers to a minimum. And that’s all they care about, not the huge shortfall that will someday hit one or both of pensioners and taxpayers.

        Its fraud.

        1. Given that they probably have to have @ half their portfolio in bonds

          That counters my “aggressive” comment. You can’t be aggressive and have 1/2 your portfolio in bonds.

          1. I’m guessing as to the “half”, really. But pensions and the like are subject to requirements on investments, and often have to hold government bonds for a significant percentage.

      2. Which is why they employ active management. Plus both boards were into alternative investments in the 2000s. When the state demands a huge return, you do what you are forced to do, and the risk goes up.

        But the Democratic governor is unwilling to move new hires into a defined contribution plan and is instead keeping the unions happy with pay raises and hoping the pension problem goes away.

        Which is like treating tertiary syphillis with Herbes de Provence and Cherokee hair tampons.

    2. I don’t think my 401K has seen that in 15 years. Strangely, I don’t get to charge my retirement to the taxpayers either.

      1. Well, that’s your mistake! Should have worked for the Government. (I actually hear that argument)

        1. Hell, I’ve made it myself, once or twice when I was very, very drunk.

  5. What is it with Pennsylvania state treasurers?

    R. Budd Dwyer

    1. Our attorney general has some trials coming up, as do the mayors of Allentown and Reading, and one of the federal representatives from Philadelphia (actually I think Mr. Fattah was convicted already).

      Pennsylvania politics is interesting.

  6. we have to question what are we getting for that money.

    I’d be pleasantly surprised if none of those fees were being recycled to the Right People. For certain values of “we”, I suspect that there is a positive answer to this question.

    1. I’m confidant all of those private investment firms (or their staff) are large campaign donors.

  7. I can’t and won’t defend those fees, but don’t be so flippant about just investing in an index. You call the DOW a conservative index, but it is just 30 stocks. It is more conservative than an all Amazon portfolio, but a pension would generally want nothing to do with an equity market risk profile (e.g., lose 40%+ in 2008).

    A pension will likely be a mix of cash, bonds, stocks and other assests skewed towards bonds. The 7.5% return assumption is way to high, but given current and future pension funding needs, it would be almost criminal to put everything in the DOW or S&P or whatever.

    And that gets to logistics. If you are investing over $60 billion in assets, that is a lot of whatever to buy. Even if you bought $50 million in bonds at a time, that is 1200 transactions, and you have to figure out what to buy, hedge duration and interest rate risk, and deal with cash flows. That is for bonds only, which would be fairly risky in its own concentrated risk way too.

    Again, not worth what they paid. But not exactly buying SPY in your scottrade account either.

    1. All in the S&P wouldn’t be the worst in the world, I totally agree with you on the Dow, and mostly on the S&P.

      But, you could reasonably put a large chunk in S&P 500, put another chunk in a midcap index fund, another chunk in an international index fund, and, of course, a bond fund.

      You can include a smallcap index if you want.

    2. “ would be almost criminal to put everything in the DOW or S&P or whatever.”

      It might be criminal, assuming the pension funds are legally required to invest in bonds, but it would still be smarter than their current approach.

      I’d go with the guy picking an S&P 500 index fund over the guy that returned 0.4 percent last year.

      1. Again, a pension should never put all its assets or generally even a majority in equities. The volatility is way too high compared to the timing of the liabilities.

        The S&P has an annualized standard deviation of say 18%. On a standard distribution you figure there is a 1/20 chance of any year losing 36%, and stock market return distributions are generally thought to have fatter tails (more likely for a big loss). That is a killer for pensions which have current and near retirees to pay.

        That is why they do fixed income. It has a lower expected return but lower volatility. It is asinine compare pension returns to the stock market or even pretend that anything but a minority of that money should ever be invested that way.

        1. “Again, a pension should never put all its assets or generally even a majority in equities.”

          How well do you think that will work if US Bond rates remain at their current level for the next 20 years? What if they go lower another 1%?

          “The volatility is way too high compared to the timing of the liabilities.”

          Why? How many funds are withdrawing more than 5% of their liabilities within a given year? If you are drawing less than 5%, holding 25% in bonds is going to cover a 5 year period. What the S&P SD for a 5 year period?

  8. my best friend’s mom makes $74 an hour on the computer . She has been without work for five months but last month her payment was $19746 just working on the computer for a few hours. find more information …

    1. Maybe state pension funds need to invest in your best friend’s mom.

  9. RE: Pennsylvania Blew $600 Million on Pension Fund Managers and Doesn’t Have Much to Show for It

    Let us all applaud and give kudos to the State of Pennsylvania and their wise and kind generosity of their citizens’ money for giving a small bunch of bureaucrats an obscene amount of money. One must ask why shouldn’t these people shouldn’t get money instead of why they should get this kind of pension. First, the lazy and the inept employed by the State of Pennsylvania should have a magnificent pension because of all the lack of work they did and the lack of effort they applied to get these pensions. Secondly, these generous pensions will send up a signal to other states so they too can give millions of dollars to state employees. Thirdly, just because Lebron earned his money by giving Cleveland its first title of any sort to that city, doesn’t mean state employees shouldn’t get the same type of pensions. Lastly, these bloated and wasteful pensions only demonstrate where our ruling elites minds are at. These wonderful people enslaving us all show gratitude where gratitude is should be placed, into the bank accounts of their fellow workers who take the time and trouble to make our lives more complicated, enslaved and miserable.

  10. It was obvious decades ago that people could never consistently beat the market. Those that fall for these “fund management” prices are suckers and the people they are paying are scammers.

    It’s the modern version of reading entrails. Well that and the weather-predicting nonsense that’s so popular nowadays.

  11. Might “damned with faint praise” be appropriate here?

  12. How can we berate liberals for using the phony “77 cents per dollar” meme in the “gender gap” discussion, and then at the same time compare pension fund returns to the S&P 500 or DJIA or whatever?

    Would you recommend a 100% allocation to stocks for someone who is retired? Because a huge portion of the people that these funds are meant for are already retired (per their “snapshot”, more than 1/3 of their members are currently retired). In 2015, they paid out 6.9B in pension payments, compared with total fund assets of $51B. So this is much, much more complicated than putting (100-age) in stocks and then drawing 4% per year during retirement.

    It’s a complete straw man to compare this situation to the average investor’s returns in an index fund.

    Furthermore, $610 million sounds like a big scary number, but on $78B of assets, that’s 0.78%. Is that really all that bad? For an index fund, it’s horrible, but for an actively managed portfolio with complex cash flow needs, it doesn’t seem all that bad.

  13. It’s not that out of line with percentage of assets managed. Many of these comments are correct. In effect they can’t swing hundreds of millions on a 1-2 month strategy to rebalance anything because the $ traded will change the price of the security. They buy through multiple second parties paying more in commissions and trade fees than the average client, and ETFs are many times off limits because of the ETFs charter to have reserves and cash available for redemptions, they need to also have options in place to balance the ETFs strategy when adding or dropping securities from the ETFs basket. In short, pension fund management is lucrative because it’s difficult. While Im sure PA overpaid and at this level there’s no way to insulate themselves from market swings, the regulatory knowledge and work to build and follow a coherent strategy to manage current pension cash flow obligations with a moderate to aggressive set of portfolios to capture better than S&W returns is no easy task. You don’t see the fidelitys /vanguards doing this business for whole pension funds, they don’t even do it for school endowments…

  14. Hudson . although Henry `s article is flabbergasting, last thursday I bought a brand new Buick after having earned $7028 recently an would you believe ten-grand this past-munth . it’s actualy the most-comfortable job I have ever had . I began this 4 months ago and practically straight away started making a nice at least $83.

  15. Ella . you think Victoria `s storry is astonishing… on saturday I bought themselves a Car after bringing in $7899 this – 5 weeks past and-more than, 10-k last munth . it’s by-far the best-job I have ever had . I began this 8-months ago and almost straight away started to earn minimum $77

  16. Start working at home with Google! It’s by-far the best job I’ve had. Last Wednesday I got a brand new BMW since getting a check for $6474 this – 4 weeks past. I began this 8-months ago and immediately was bringing home at least $77 per hour. I work through this link, go to tech tab for work detail.

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