Pennsylvania’s pension plan for teachers is at war with itself over how to invest its mammoth $70 billion fund.

Put aside the lingering FBI investigation. Forget the plan’s botched calculation of its profits. For the deeply split board, a fundamental issue remains whether to keep pouring billions of dollars into hedge fund start-ups, private-equity takeovers, and eclectic real estate plays rather than old-fashioned U.S. stocks and bonds.

PSERS — the acronym for the Public School Employees’ Retirement System — pioneered public investment in such “alternatives.” To a striking degree, it remains much more heavily invested in them than its counterparts across America.

With terrible timing, the fund prioritized alternatives in the last decade after the stock market took a major plunge. It has held on to a poor hand as stocks have come roaring back.

PSERS in recent years has put more than half of its billions into these alternative investments. According to pension experts at the Pew Charitable Trusts, no other big public retirement fund has made so large a bet.

It hasn’t paid off. The same Pew 2019 report on nearly 75 major retirement plans found PSERS’ overall profits to be second from the bottom over 10 years. A more recent study put its 10-year returns through 2020 at 7.7% — the fifth worst in a 24-fund group.

» READ MORE: Amid PSERS troubles, Pa. lawmakers may be ready for pension reform

It’s not surprising that, given how the fund has doubled down on alternative investing, it has been a top payer of fees to the Wall Street money managers who recommend them. Pew found that only two other plans paid a bigger percentage of investments to advisers. In 2019, for example, PSERS said it paid more than $700 million to 170 outside managers.

Taxpayers account for most of the system’s funding ― putting in nearly $5 billion last year, more than four times the $1.1 billion from school employees. Investment profits have averaged about $4 billion yearly, though the fund said Friday the investments performed markedly better in the last fiscal year.

Backers of alternative bets say the strategy can pay off big. In June, James H. Grossman Jr., PSERS’ beleaguered investments chief, told the plan’s board about one such winner: He said an $85 million investment in a California maker of trendy nurses’ scrubs had ballooned on paper, at least, into a $329 million stake in less than year.

To the critics, the investments are too hard to value, too expensive, too illiquid, and require oversight beyond the capability of Grossman’s investment unit. His 50 experts are among the highest paid employees in state government, starting with Grossman himself. His yearly salary is $485,000, twice Gov. Tom Wolf’s.

The detractors question the bewildering range of alternative investments, from a private-equity firm accused of gouging prisoners with exorbitantly priced phone calls, to a company buying mobile-home parks across 10 states, to the pistachio groves that PSERS owns in California.

In one investment that has provoked derisive commentary, an outside manager invested $5 million of PSERS money in oil fields in a Kurdistan war zone. They were promptly seized by the Iraqi army, cutting off payments to investors.

All of the internal quarrels came to a head in June when a six-member dissident bloc on the 15-member board tried and failed to fire Grossman and executive director Glen Grell. Yet at the same time the board tabled a call from the two executives for an additional $1 billion in alternative investments. The board delayed a decision on such investments again on Friday.

The revolt came after news that the FBI has been investigating the fund over two apparently unrelated matters: its real estate purchases in Harrisburg and its mistaken adoption of an exaggerated figure for its investments returns. An embarrassed board adopted a new lower figure in April, a step that also required it to increase the pension paycheck deductions last month for 100,000 teachers. The board had previously increased the payments required of taxpayers.

In his new academic research, Richard M. Ennis, a former consultant to public pension plans, took note of PSERS’s relatively poor profit results.

“I have found that underperformance is directly and strongly related to the percentage allocation to alternative investments,” he said in an email to The Inquirer.

Chester S. Spatt, a finance professor at Carnegie Mellon University and former economist with the U.S. Securities and Exchange Commission, had a similar reaction.

“What grabbed me about Pennsylvania [teachers’ plan) was this exposure to alternative investments,” Spatt said in interview. The strategy had pulled down returns, and he called it “ridiculous and an abuse of the public trust.”

Last week, the fund predicted that its overall rate of return would exceed 25% for the fiscal year that ended in June. Still, that figure would trail the S&P 500 stock index for the same period. Those stocks rose 38%.

Here’s a look at some of the plan’s major alternative investments and why they have sparked skepticism.

Energy partnerships

In 2012, PSERS’ investment experts advised the fund’s board that they had found a way to reap extra profit from a then-resurgent U.S. oil and gas industry: Pump money into so-called master limited partnerships to invest in fuel and pipelines. The pitch was that these partnerships were far more nimble than the big, staid oil giants.

Some would even have access to inside information. As a PSERS adviser gushed to the board, one partnership packager, Salient Capital Advisors, was “based in Houston, Texas, widely considered the MLP capital of the world. The location is ideal,” given Salient’s “professional relationships with key industry executives, which helps drive information flow.”

Another in the game was Harvest Fund Advisers, led by financial professionals in the Philadelphia suburbs. Harvest put PSERS money into energy infrastructure providers such as Energy Transfer Partners, successor to the former Philadelphia-based Sunoco and owner of the much-protested Mariner East pipelines to a Marcus Hook gas works.

In the end, PSERS sunk more than $2 billion into Salient, Harvest and a third partnership manager, Baltimore-based Atlantic Trust. The fund said this had “reduced its investment risk.”

Early on, others were unconvinced. In 2013, the Financial Times newspaper noted that PSERS had led a pension-fund charge into MLPs but warned that these energy partnerships had peaked financially — and cautioned that some who invested in them couldn’t distinguish “between the best and worst fund managers.”

To be sure, the partnerships initially did well, rewarding PSERS’ decision while oil prices were rising. The value of the fund’s partnership stakes hit a high in 2018 at more than $2.6 billion.

The gigs were lucrative for fund managers, too. By 2020, the retirement system had paid them $65 million in direct fees. The managers also collected a cut of the pension fund’s profits. PSERS won’t say how much. It has revealed such payments only for more recent deals.

But returns faded. Philadelphia’s municipal pension fund bailed completely from them in 2017. By then, “we had exited the space entirely,” Chris DiFusco, the municipal fund’s chief investment officer, said in an interview. “The board, staff and consultants simply felt more comfortable with a different kind of energy exposure, primarily through broad market indexes,” like the S&P 500.

In Harrisburg, PSERS’ experts were undaunted. In a 2018 annual report, the fund said it planned to put even more money into the partnerships.

In the end, it was a bad bet. As energy prices dropped back, records show, the fund’s fuel partnerships lost money. Their value fell most dramatically last year, plummeting 35% — an $800 million loss. As Grossman put it this spring in a board session, the investments had had “a very bad year.”

Finally, PSERS decided to get out, just as Philadelphia had. In June, Grossman told the board that the fund’s investment would soon be “down to zero.”

The saga especially pained former state Treasurer Joe Torsella. He is the board dissident who has long argued that PSERS should embrace a so-called passive investment strategy, akin to that pioneered by Vanguard, relying on market indexes — broad baskets of stocks — rather than following an “active” approach based on the advice of highly paid consultants.

“We’re abandoning a failed effort on MLPs that has cost us $1 billion,” Torsella told his colleagues at one point.

Ray Dalio’s Bridgewater Associates

For many investors, Ray Dalio is in the pantheon of financial innovators. He built his Bridgewater Associates into the world’s largest hedge fund, renowned, if not notorious, for its confrontational workplace culture where its 1,500 analysts, junior and senior, are encouraged to question each other’s decisions. Bridgewater says it has delivered $58 billion in profits for its customers over the last 40 years.

For PSERS, though, returns have not always been awesome.

At its peak in 2020, the state fund had more than $4 billion invested with Bridgewater, more than in any other firm.

The Pennsylvania fund was an early and enthusiastic adopter of a strategy that Dalio invented known as “risk parity,” a term for creating curated funds that could gain value even in hard times. The idea is to carefully select a mix of stocks, bonds, commodities and other assets that address varying market conditions. PSERS staff liked the concept so much that it also put hundreds of millions of dollars into similar funds by three of Bridgewater’s rivals.

In PSERS’s case, risk appears to have won out of over parity.

Over the last five years, the pension system has reported, Bridgewater and the other risk-parity funds in which PSERS put money have delivered only a 4.4% profit — trailing badly behind even other risk-parity players in a comparative index built by PSERS itself. That index averaged a 7.4% return, a figure still under the return during those years for domestic stocks.

For fiscal 2020, the year of the COVID-19 pandemic, PSERS’ risk-parity returns were especially poor — just one-tenth of 1%, versus more than 10% for the comparative index.

“We’ve fallen short of the policy benchmark,” confessed Thomas Bauer, one of Grossman’s two deputies, during a board meeting last year.

“The benchmark looks great,” Torsella said. “But Bridgewater’s not reaching it.”

“In this crisis,” Bauer said, referring to the pandemic, “this did terrible, which should make us mad. A manager we paid a lot of money to, that was supposed to do well in a crisis.”

”It seems a little insane,” Torsella added. “Get rid of these managers. It’s an expensive lesson.”

“Risk parity is gone,” concluded Jason Davis, the high school teacher of economics who chairs the system’s investment committee.

As The Inquirer has previously reported, PSERS’s investment staff travels frequently, sometimes at great expense, to check up on investments. Over the last three years, the fund has sent staff repeatedly to Bridgewater’s headquarters in Westport, Conn., along with trips to Beijing on Bridgewater-related matters. The total travel cost was $23,000.

In a June letter calling for the firing of top PSERS executives, the dissidents on the board noted that the fund had paid Dalio’s firm $560 million in fees over the years. The letter also observed with irritation that a top Bridgewater executive had been booked to come to Harrisburg to run an “educational session” for the board, something the dissidents saw as little more than a sales pitch.

“Business as usual,” their letter said.

While the PSERS fund has unwound the risk parity bets, it still has about $2 billion remaining under Bridgewater’s control in other financial instruments. Those investments have produced returns about the same as the S&P 500 stock market index funds —but with much higher fees.

PSERS’ real estate investments

In exercising its penchant for alternative investments, PSERS has also dabbled in direct ownership of real estate across America. In all, it directly owns several dozen properties worth about $1.2 billion.

There’s the pistachio tree farm south of Fresno, the mobile home parks in the Midwest and South, and a hotel in Atlanta.

Closer to home, it has spent $10 million since 2017 to buy and raze industrial buildings near its Harrisburg headquarters. As The Inquirer has reported, federal investigators have subpoenaed information from PSERS about those acquisitions. The fund has not disclosed what has troubled the FBI about the deals.

Criminal investigations aside, one particular real estate venture — a mall in southern Florida — has been a particular headache for PSERS. Not even a later effort to bring in sharks helped it.

PSERS bought the Galleria at Fort Lauderdale in 1993, paying $125 million for the 1.4 million-square-foot shopping center, slightly larger than the Willow Grove Park Mall.

Five years later, it tried to sell the place. There were no takers. It was once one of the area’s hottest fashion destinations,” but under PSERS it “stagnated,” the Miami Herald reported.

Starting in 2001, the fund spent $44 million more to cart in palm trees, open up windows, and lay down a floor of three colors of marble so the Galleria no longer “felt dingy,” as the project’s architect put it.

As the work neared completion in 2003, Lord & Taylor pulled out. In 2008, Saks left, leaving as anchors a Macy’s, a Dillard’s and a Neiman Marcus.

In 2013, the PSERS board endorsed a staff proposal to sell land next to the mall to a developer with the idea of building a $1 billion apartment complex with a 45-story tower, a move the staff said would boost traffic at the mall and increase its value. Fort Lauderdale officials killed the plan due to neighborhood opposition.

In 2018, aquarium operator SeaQuest proposed filling the long-vacated Lord & Taylor space with 1,200 sharks, stingrays and other sea life to entertain shoppers and lure tourists. Animal-rights activists protested. The plan died.

In 2019, the fund poured $25 million more into Galleria improvements. “It required extensive renovation,” Charles Spiller, one of Grossman’s two deputies, said at the time. He added: “We like the property. It’s gone way up in value over the years that we owned it.”

Despite the infusion, PSERS had been lowering the mall’s estimated value in recent years, internal reports show. Early in last year’s COVID-19 outbreak, Neiman Marcus filed for bankruptcy protection and announced it was closing four stores nationwide — including the anchor store in Fort Lauderdale. The store closed in September.

In sum, the mall’s performance in 2020 “was not good. We took a write-down in valuation,” and also reduced store rents, Melissa Quackenbush, a PSERS staffer who oversees real estate investments, told the board.

And consider this: PSERS originally paid $125 million for the Galleria. Had the fund put that amount into S&P 500 stocks in 1993, that investment would be worth well over $1 billion — more than three times the mall’s current value.