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Are public pensioners and taxpayers paying for investment performance?

July 23, 2021

There aren’t a lot of $100 bills lying around on sidewalks. If they were there, somebody would have picked them up.

That’s the kind of reasoning underlying the “efficient markets hypothesis” in finance. It isn’t easy to beat the market because if it were easy, somebody would have already done it.

Granted, markets aren’t always right, either. Crowd psychology and public policy can move things around in ways that aren’t always right, or at least, sustainably right. 

But markets are hard to beat – and in turn, paying experts lots of money to try to beat the market may not make a lot of sense if, on average, they can’t do it.

Yet for public pensions, we pay lots and lots of experts lots and lots of money to do what they, collectively, can’t do on average. Is this irrational? Not if rationality means that well-organized interest groups dominate public policy, including public pension design and investment management, in ways that enrich a few at the expense of the many.

Citizens and taxpayers have a direct stake in the management of public pension assets. Particularly in places like Illinois, where an Illinois Supreme Court ruling a few years ago cemented the obligations of governments to retirement plans. If risky investment strategies are employed, taxpayers and citizens are exposed to the downside to make up any greater shortfall that arises. 

In turn, those investment strategies also matter for taxpayers if the riskier and/or less-transparent management costs a lot of money for generally-overpaid experts who are drawing on the public purse.

As woefully underfunded as many public pensions are, it bears underlining that they are only underfunded in relation to the massive liabilities that many state and local governments have accumulated. These plans manage many, many billions of dollars in invested assets. 

Consider the Teachers’ Retirement System (TRS) of Illinois. At its latest fiscal year-end, the plan reported a funded ratio of just 39 percent, meaning that it had less than four dollars in assets for every $10 in the present value of promised benefits. TRS reported a total liability for the plan at fiscal year-end 2020 of $136 billion, backed by “just” $52 billion in invested assets.

Fifty-two billion dollars is still a lot of dough. Paying folks to manage it can cost taxpayers and pensioners a lot of money.

So we should have good information about how much it costs to manage pension assets, right?


Let’s take a peek at another Illinois plan – the Policemen’s Annuity & Benefit Fund of Chicago, the retirement plan for Chicago cops. At year-end 2020, the plan had more than $2.7 billion in investments, but the plan’s “fiduciary net position” was only about one-fifth of the present value of its promised benefits. Here’s what the latest audit report had to say about disclosure of investment fees:

Investment management fees from equity and fixed-income managers, including one of the collective funds, one of the private equity managers, and the cash manager, are included in investment management fees on the statements of changes in fiduciary net position. Investment management fees from all other collective funds, short-term investments, infrastructure, hedge, real estate, venture capital and private equity are reflected in the net investment income from such investment products. Such investment management fees are not significant to the financial statements.

At year-end 2020, this fund had about $800 million in “collective investment funds,” $220 million in hedge funds, $140 million in real estate investments, $110 million in venture capital and private equity investments, $100 million in short-term instruments, and $68 million in “infrastructure” investments. If experts were being paid two percent (annually) of the $1.4 billion in those investments, it would amount to about $30 million a year.  

But we don’t know what the true compensation rate is because “such investment management fees are not significant to the financial statements.”

Back in 2019, a study by Oxford University finance professor Ludovic Phalippo indicated that Pennsylvania’s two largest public pension funds paid out more than $6 billion in fees and related compensation to investment managers over one decade, about three times as much the systems had been disclosing, importantly due to issues related to profit-sharing arrangements with private equity firms. 

More recently, the trustees of Pennsylvania’s largest pension fund confirmed in April 2021, in response to a reporter’s inquiry, that it was under federal investigation for related issues about calculating investment performance and investment transactions potentially related to “kickbacks and bribery.” 

Coincidentally or otherwise, in March 2021, the staff of the Government Accounting Standards Board (GASB) prepared a research paper on investment fees in public pension plans, with a view to informing the GASB Board about issues that have been raised about investment fee disclosure. But in April 2021, GASB voted to not add the issue to its Technical Agenda.

We will be taking a closer look at that paper soon.

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