Burn Money

Maryland Public Pension: A Case Study on How to Waste Money

Burn Money

Public pensions have a very simple purpose: to help serve the many public employees and their retirement. What they have turned into is a shining example of wasting taxpayer money.

The Washington Post recently published an article highlighting the $320 million in fees that the State of Maryland paid for professional management of its state pension plan. That is no chump change. While services rendered are never free or necessarily cheap, it begs the question of what exactly are these professionals being compensated for?

Like most public pensions, Maryland has embraced the investment model made famous by David Swensen, Chief Investment Officer of the Yale University endowment. As acutely described in a Forbes article, “they (Swensen & Takahashi) suggest that investors, such as endowments and public pension funds, can achieve superior returns by shifting a significant portion of investments away from traditional stocks and bonds and into carefully selected hedge funds, private equity, real estate, and other alternatives.”

Over the 20 years, Swensen’s returns have been impressive and have inspired many to follow in his footsteps. But the reality about it being a prescription for investment excellence has not stood the test of time. In fact, every single major state public pension plan has underperformed a simple buy and hold strategy of globally diversified portfolios made up of index funds.

In 2011, Index Fund Advisors started to collect performance data of all major state pensions in an attempt to answer the question, “does their active management produce superior results?” To our surprise, not only did they underperform simple portfolios of index funds, they underperformed significantly. For the 13 years ending 6/30/2013, Maryland delivered an annualized return of 3.47% although is had a similar risk profile to that of IFA Index Portfolio 65, which delivered an annualized return of 7.93% over the same time period. That’s more than double. More impressive is that Maryland was the worst performing state during that time period. See chart below.

Going to our original question, what exactly are taxpayers paying for in $320 million per year in professional management fees? The vast majority of these fees are being funneled to professional consultants to pick the “right” private equity and hedge fund managers. While there is no reliable academic source that private equity and hedge funds can provide superior returns, many public pensions continue to pay the big bucks for access. As we have shown in our own analysis, these consultants have failed to deliver on their value proposition. Many state pension plans have succumb to the same reality.

A Washington DC based financial analyst, Jeff Hooke has long suggested that Maryland, like many other states, “should bid farewell to high-cost financial wizards and shift more money into passively managed index funds such as those that mimic the Standard & Poor’s 500-stock index.” Mr. Hooke eloquently describes the illusion that has become the active management industry. “Their sales pitch is that they can do better than index funds—that they can beat the stock market and bond market and be less risky. You look at the facts, and they’re not beating the indexes. They’re not picking the right stocks and bonds, yet they’re charging much more for comparable investments….It’s like a triumph of marketing over common sense.”

This common sense is, unfortunately, not so common. While some public pension plans like California (CALPERs) have steered away from the Yale Model in recent years, many public pensions continue to believe that this is the best use of taxpayer money.

The more unfortunate consequence of this reality is that many public pensions have become underfunded in terms of being able to meet their legal obligations to future retirees. In the realm of a public budget, this means that more money will have to be dedicated to these future obligations and steered away from other public initiatives such as public safety, education, and infrastructure. This is not because of unfortunate events, but because of a choice made and continues to be made by public officials charged with protecting the retirement funds of public employees. When presented through this lens, what is at stake in terms of gambling with public pension money is the suffering of all citizens. They will have to pay for something in which they receive nothing of value in return.

We are surprised there hasn’t been more of an outcry from the citizens of Maryland and we hope that public officials will wake up an realize the magnitude of their waste.