Pension-Gate

In the 2009 edition of Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment,1 Yale Endowment Chief Financial Officer David Swensen states, "Active management strategies, whether in public markets or private, generally fail to meet investor expectations... In spite of the daunting obstacles to active management success, the overwhelming majority of market participants choose to play the loser's game."

Despite Swensen's admonition, active manager selection and termination remains a common practice among public pension plans. Plan sponsors hire investment fund managers whom they expect to deliver above benchmark returns.

An investigative journalist for St. Petersburg Times, approached Index Fund Advisors (IFA) and a handful of other investment experts to collect some in-depth analysis of the risks and returns of the Florida State Pension Plan for various periods of time relative to various index portfolio strategies. The research results were revealed in a July 31, 2011 article titled, "Easy investments beat state's expert pension planners,"76 which concluded that a simple index portfolio would have outperformed the Florida state pension plan's investment performance over the last ten years.

"The professionally managed SBA [State Board of Administration] performed worse — by more than a percentage point — than seven index-fund portfolios for the decade ending Dec. 31, 2010," the article reports. "On average, a $100 investment in an index portfolio grew to $184, while Florida's pension delivered just $157," the reporter concluded.

The findings prompted further query for IFA. If Florida's $124 billion pension plan fared so poorly against the index portfolios, what about the other states? IFA has attempted to analyze the employee retirement systems in all 50 states. Data on more than 40 state pension plans have been received to date, yielding similar results with varying degrees of underperformance relative to the index portfolios.

Figures 5-7 through 5-10 show the annual risk and return of various state pension plans, net of fees, compared to passively managed index portfolios comprised of a blend of diversified asset allocations. A best effort was made to estimate fees in states that report returns before fees are deducted.  States were analyzed for both 13-year periods and 26-year periods and were charted based on either a June 30th or December 31st year-end date. The data shows that in the 26-year study, only 2 states (South Dakota and Delaware) matched the index portfolios, and not one of them outperformed in any of the time periods analyzed. For data sources, go to pension-gate.com.

Figure 5-7 2

Figure 5-8 3

Figure 5-9 4

Figure 5-10 5

Directors of these pension plans have access to so-called "top" money managers, which would lead one to believe that these plans fired their very best shots at earning above-benchmark returns, only to fall short. This analysis reveals that the widely implemented and costly process of hiring and firing of investment managers for state pension plans has delivered a negative payout relative to a risk-appropriate set of index benchmarks.

    -1 Swensen, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment (New York: The Free Press, 2000).
    -2 Sydney P. Freedberg and Connie Humburg, "Easy Investments Beat State's Expert Pension Planners," St. Petersburg Times (St. Petersbug, FL), Jul. 31, 2011.
    -3 State Retirement Systems Data from public information, includes states that provided 11 and 24 yrs of returns for fiscal years ending 6/30, and are net of fees; Index Portfolios are net of fund fees and 0.05% Advisory Fee. See www.pension-gate.com/ states for additional disclosures.
    -4 Ibid.
    -5 State Retirement Systems Data from public information, includes states that provided 12 and 25 yrs. of returns for fiscal years ending 12/31, and are net of fees; Index Portfolios are net of fund fees and 0.05% Advisory Fee. See www.pension-gate.com/ for additional disclosures.
    -6 Ibid.
Step 5State PensionDavid Swensen