To help pay retired police, teachers, judges, and other public workers, Pennsylvania's state worker and public school pension plans invest $80 billion, one of the big pots of gold in American investing.
A new report from the school plan (PSERS) shows firms have collected more than $5 billion in previously unreported "profit sharing" from private investment managers since 1980, including more than $1 billion in the last two years alone. That's more than the direct fees the pension plans have posted in their annual reports to legislators and members. PSERS hasn't yet detailed who collected how much. The state workers' system (SERS) hasn't reported even the totals.
For years pension officials didn't provide that information, saying that they didn't know, that other pension plans didn't tell, that they aren't really fees, that it doesn't matter because investment returns are reported after fees. Now the school plan, at least, is telling more, after pressure from Gov. Wolf, State Treasurer Joe Torsella, and other elected officials anxious that the plans' expenses keep growing faster than their profits, squeezing state and school budgets and raising natural questions about whether the people in charge know what they're doing.
Indeed, a consultant to the Pennsylvania Treasury says in a recent report to Wolf's pension fee commission that the SERS and PSERS boards, manned by legislators, state officials, retirees, and government and labor interest-group reps, are not up to the job. Despite long monthly meetings and reports from staff and outside advisers, he argues the trustees (who collect $100 a day, plus meals and expenses, if they're not public employees), are not equipped to evaluate the plans' complex long-term investments — commodity and hedge funds, derivatives, global real estate and buyout funds, and much more.
The report by Ashby Monk, who heads a Stanford University research center and advises the University of California and other rich investors, makes pension-fund overseers sound a bit like weekend gamblers in a casino full of pros.
To be sure, both systems have endorsed calls for better board prep, and PSERS has asked to hire more staff so it can pick investments more efficiently. Maybe it's reassuring that SERS and PSERS trustees have lately divided over investment proposals, even for big firms like Apollo Global Management.
These investment decisions are made against a backdrop of fiscal pressure: The pension plans expect to owe almost twice as much money as they have set aside to pay pensioners. After long neglect under Govs. Tom Ridge and Ed Rendell, this shortfall, a factor in Pennsylvania's low bond ratings and high borrowing costs, is being bridged through state and school district contributions, which add more than 30 cents to every dollar in state and school pay. (The workers made smaller contributions.)
Starting in July, new hires will be given smaller pension guarantees, easing future funding pressure. But that doesn't solve today's deficit. Anxiety over pension expenses led to the state's latest reform effort, the Pennsylvania Public Pension Management and Asset Investment Review Commission, a five-man panel that held hearings this year and will send a final report, with cost-cutting recommendations, to Wolf next month.
Torsella, the commission's vice chair under the chairman, State Rep. Mike Tobash (R., Schuylkill Haven), hired Monk to review the pension systems' governance. Monk submitted his "Analysis and Recommendations" in testimony at the Oct. 25 hearing. Some highlights:
"The capacity, resourcing, and expertise of the respective Boards of the two Pennsylvania plans does not seem to be aligned" with their mission, Monk wrote. The boards lack resources, and "the complexities and risks" in the investments they approve each month "are likely not fully appreciated" by board members. "This is problematic."
The "PSERS board does not appear to have the expertise to be able to adequately oversee the current complex strategies employed by [its own] Investment Office," Monk added. PSERS trustees show "an over-reliance on investment staff and consultants" whose interests don't necessarily line up with the state's or the pensioners'.
The SERS board, which suffered "upheaval" leading to top management turnover in the Corbett administration, admits it "relies heavily" on outside consultants whose "value," Monk wrote, "has been found to be questionable," citing performance studies by himself and others. With 350 private-equity managers and 50 real estate managers, SERS faces "an extremely large undertaking" in trying to "accurately monitor and scrutinize" their performance.
Instead, Monk suggested a separate "businesslike" investment board made up, not of retired math teachers or state reps, but, for example, "successful business executives," who have handled large investments. (Delaware, whose pensions are more solvent, has such a board. So do successful pension plans such as the ones in Wisconsin and Florida, Monk wrote.)
PSERS and SERS have been defending themselves from, in particular, Torsella's allegations, as aired in a widely circulated London Financial Times article last summer, that they have been "wasting" billions in fees paid to managers who failed to outperform U.S. stock index funds — despite tying up state money for years waiting for profits. PSERS denies wasting state funds.
PSERS last month gave the commission a report disclosing total shared profits it has agreed to let its hedge fund and real estate management firms keep over the last 38 years, in addition to previously reported fees. As cost-cutting calls have mounted, PSERS and SERS have said they have reduced investment fees. PSERS, for example, says net fees directly paid to managers dropped to $224 million last year, from $227 million the year before.
But those shared profits that managers are allowed to keep rose sharply last year, and have totaled more than double reported fees, the new PSERS data show. Private managers kept $669 million in profits from PSERS investments last year, up from $485 million the year before.
Profit sharing rose last year because there were more profits to share: PSERS' slice of managers' investment profits also increased, to $2.4 billion last year, from $1.8 billion the year before.
Since those profits are reported net of fees, PSERS and SERS can argue that fees don't directly cost the state anything. Indeed, even very high fees can be justified — if PSERS' and SERS' investment performance is better than it would get buying much cheaper portfolios of stocks and bonds.
SERS and PSERS claim they are outperforming the markets — about 1.1 percent a year, compared with a 60/40 mix of Morgan Stanley world stock indices and Bloomberg Barclays bond indices, SERS says.
But Monk's analysis shows periods of better performance are outweighed by the higher risk of losses the funds face, as they tie up billions for years in illiquid private investment portfolios. Both PSERS and SERS dropped tens of billions in the 2008-9 market crash when private investments failed to perform as advertised and they felt pressure to liquidate assets at deep discounts. "The risk-adjusted performance of both plans, against very simple" U.S. or multinational stock index and bond combinations, "has been very poor," Monk concludes, comparing the pension returns to public-market index benchmarks and interest rates.
I hope the commission's final report makes useful comparisons layman-clear. And SERS and PSERS are going to need to keep telling us more about the terms and the amounts by which they enrich the private money managers they rely on, if they expect the people to buy their arguments in favor of their independence under citizen amateur trustees.
Monk's Analysis and Recomendations
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