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PSERS, in a sweeping shift, agrees to buy more U.S. stocks and dump costly hedge funds

The new asset allocation represents a big shift for the giant pension fund.

Richard Vague is Pennsylvania Gov. Tom Wolf's banking secretary. As a trustee of PSERS, he has argued for simpler, more efficient investments. Photographed at a regular board meeting at PSERS offices in Harrisburg, Pa., on June 11, 2021.
Richard Vague is Pennsylvania Gov. Tom Wolf's banking secretary. As a trustee of PSERS, he has argued for simpler, more efficient investments. Photographed at a regular board meeting at PSERS offices in Harrisburg, Pa., on June 11, 2021.Read moreTYGER WILLIAMS / Staff Photographer

In a dramatic turnaround for Pennsylvania’s beleaguered public schools pension fund, the PSERS board agreed Thursday to sell all of the plan’s hedge funds and nearly double investment in U.S. stocks.

The shift in financial policy comes after years of debate between traditionalist and dissident board members who engaged recently in a series of acrimonious exchanges.

This week, the most insistent voice for change was that of board member Richard Vague, the businessman who is Gov. Tom Wolf’s banking secretary. On Wednesday, during the first of three days of board meetings this week, Vague warned his colleagues that dissidents would not back down from their demand that PSERs lessen its years-long reliance on costly investments in hedge funds, private-equity firms and the like.

The banking secretary told the panel that continued disagreement among trustees would surely lead to renewed “emotion and contention and newspaper stories.” He added: “We want that to go away.”

Along with the big boost in stock investments, the plan appears poised now to slash its holdings in hedge funds to zero from 8% of its vast portfolio. Last year, in a previous rollback, the fund had more modestly trimmed the hedge-fund allocation from 10% to 8%.

The 15-member volunteer panel appeared to reach a new consensus Thursday, striking an apparently unanimous oral agreement to shake up the plan’s fiscal allocations. The panel is to formally vote on the overhaul at its December meeting.

PSERS — the Public School Employees Retirement System — sends $6 billon yearly to 250,000 former teachers and other retired school workers. The fund has been roiled not only by the fierce debate over its investment policies but also by subpoenas from the FBI and federal financial regulators who are investigating the plan.

Authorities have subpoenaed documents about the fund board’s mistaken adoption, recanted this spring, of a false and unduly rosy number for investment profits. The lower investment returns have resulted in some employees having to contribute more to their pension plan, and to taxpayers having to kick in more money.

Also, in a wide-ranging probe, authorities have been digging into the fund’s purchase of real estate near its headquarters in the state capitol and whether staff had accepted improper gifts from the firms that do business with the system.

Vague lined up support for the proposal that would boost U.S. equities to 21% of the $70 billion overall PSERS portfolio, up from the current 11%. Speaking in support of the measure Thursday were state Treasurer Stacy Garrity, former treasurer Joe Torsella, and state Rep. Frank Ryan (R., Lebanon).

Since the stock market collapse of 2008, PSERS has favored high-fee, Wall Street “private” investments — corporate-buyout funds, hedge funds and such — over U.S. stocks. In sharp contrast, the dissidents back a less dramatic style of investment, a Vanguard-like approach that relies heavily on indexing common stocks.

As of last year, PSERS’s policy was to have less than one-fifth of its billions invested in stocks, including both U.S. and foreign. By contrast, the median for 50 large U.S. pension funds was to put nearly half of their money in stocks, according to research by Verus, a Seattle firm that advises PSERS.

PSERS had 10 times the other plans’ investments in commodities such as oil, and put double on what they invested in hedge funds, choices the critics say have dragged down its returns. It also owned more private equity than the typical state plan.

For PSERS, its investment returns have been on a bumpy ride.

In the fiscal year ending in 2020, the year of COVID-19′s arrival, profits were just 1.1%. Since then, the fund has been trumpeting its 25% investment return for the year ended June 30, as the economy rebounded sharply.

Yet the other big public fund in the state, known as SERS for state workers, saw returns hit 28% for the same period. Had PSERS done as well as those plans, it would have collected billions more, as Ryan told his board colleagues.

PSERS’ returns as of June 30 ranked it in the bottom 40% of comparable funds for the past one-, three-, five- and 10-year periods, analysts said.

While some consultants defend hedge funds as stable assets immune to stock market gyrations, Torsella pointed to years of weak returns by that asset class.

“Has it done better than if we put money in a mattress? Yeah, a little bit,” he said.

Former teacher Melva Vogler, the longest-serving board member and a reliable supporter of fund management, did not object to the new asset allocation.

Still, “I’m a little nervous about not following our staff or our advisers,” Vogler added.

Jason Davis, the Western Pennsylvania high school economics teacher who heads PSERS’ investment committee, asked if this is really a good time to load up on high-priced shares.

He also noted the fund purposely downplayed U.S. stocks after the market crashed in 2008 so it would not again feel trapped into selling stocks cheap to pay pensions the next time the market crashes.

But Christopher Santa Maria, the history teacher from Lower Merion who chairs the pension board, discounted that risk.

“These portfolios don’t look anything like what we had in 2008,” he said.

Even with the proposed changes, the fund is far more diversified and likely to lose less in a crash, he said.

At the end of the session Thursday, Davis asked whether anyone remained opposed to the change. Hearing no protest, he called on advisers to prepare a detailed proposal that the board is to take up for a vote in December.