Index Funds Advisors, Inc. has repeatedly called attention to the scandalous waste of money on active management by state retirement systems. Last week, The Maryland Public Policy Institute and the Maryland Tax Education Foundation issued a report by Jeff Hooke and Michael Tasselmyer titled, "Wall Street Fees and the Maryland Public Pension Fund" which concluded the following:
"State pension systems represent the retirement security of millions of public employees across the nation. In Maryland, confidence in the strength of that safety net is beginning to erode…the administrators of Maryland's pension systems would be wise to index the systems' portfolios to ensure average investment returns. This would be a safer, more responsible use of system resources than paying Wall Street management firms millions of dollars each year to deliver sub-par results."
The authors' designation of "sub-par" may have been too kind, for of all the states for which IFA tabulated eleven-year returns, Maryland was close to the bottom, as can be seen in the chart below which shows reward (annualized return) vs. risk (standard deviation) for 24 state pension plans and 7 IFA Index Portfolios of comparable risk. Adding insult to injury (and also providing an explanation of this result), Maryland spent $221 million (0.69% of assets, the fifth highest in the country) on Wall Street money management fees for the fiscal year ending June 30, 2011. For all 50 states, the cost is a breathtaking $7.8 billion, of which at least $6 billion could be saved by moving to indexing strategies. The authors estimate that Maryland's needless expenditures combined with its performance shortfall has cost the state approximately $3 billion over the last ten years. To put it in more concrete terms, the annualized average return received by Maryland over the ten years ending June 30, 2011, was 5.0% compared to 5.9% for all the state public pension funds and 7.5% for IFA's Index Portfolio 50 (net of a 0.05% advisory fee).
In response to the dismal performance of their equity and fixed income investments, Maryland and many other states have shifted funds into alternative investments such as private equity and real estate. The authors note the drawbacks of alternatives such as their lack of liquidity and transparency. IFA has detailed the problems with private equity in general and venture capital funds in particular.
We at IFA applaud the efforts of Hooke and Tasselmyer. We only hope that the directors of Maryland's State Retirement Pension System take notice and act accordingly. Furthermore, we hope that Maryland starts a trend that spreads to all the other states. As Alexander Pope said, "Hope springs eternal."