Pension-Gate - Good News from Pennsylvania


A few months ago, we reported on how CalPERS (the $260 billion California Public Employees Retirement System pension plan) was considering dropping its current active approach to embrace a more passive investment strategy. Naturally, we encouraged (and continue to encourage) them in this direction, as such a move would save the taxpayers hundreds of millions of dollars annually and reduce the chances of repeated scandals such as the criminal charges that were filed against former CalPERS CEO Federico R. Buentostro, Jr. and Mr. Alfred J. Villalobos, a private placement agent for the pension fund in connection with a “pay-to-play” scheme. Specifically, they are accused of forging compliance documents in order to receive about $14 million in bribes from one of the private equity firms with which they were placing assets. Outrageous!

From Montgomery County, Pennsylvania comes the refreshingly good news1 that they are dumping most of their actively managed funds in their county pension fund in favor of passively managed funds offered by Vanguard, whose headquarters is only thirteen miles away. According to Josh Shapiro, chairman of the Montgomery County Board of Commissioners, the move is expected to reduce investment fees by roughly two-thirds (from 0.43% of assets to 0.13%). As Shapiro put it, “There is no value for the county and other municipalities to be spending these fees and getting a lower return.” If this sounds like something John Bogle would say, there is a very good reason for that, as this decision was inspired by a meeting that Bogle had last year with county officials at their request. While the Wall Street Journal did an excellent job in covering this story, there is one part of the article cited below that we would take issue with:

“Montgomery County's gambit is akin to abandoning a fully loaded sports car in exchange for a bicycle. Active managers usually employ multiple investment strategies and move money in and out of various products to try to achieve high returns. Index funds, by comparison, hold a range of stocks and bonds over a longer term that often reflect the broader market. They charge lower fees because they often involve less frequent trading, and less manpower.”

This analogy is flawed because it conveys the idea that by paying more for an actively managed fund, you can expect a higher return. Although far more costly, a fully loaded sports car will normally take you a lot farther and faster than a bicycle. Unfortunately, the overwhelming body of research concludes that active managers as a group not only fail to beat their appropriately designated benchmarks, but they tend to lag their benchmarks by the amount of their expenses. One example is the Standard and Poor’s Index Versus Active Scorecard. This does not mean that there aren’t any managers who have beaten their benchmarks, but such managers are uncommon, have a very low rate of persistency, and usually cannot prove that their performance was due to anything other than luck.

One aspect of this story that we find particularly delightful is that the $423 million of actively managed funds that Montgomery County is dumping were largely provided by the major Wall Street firms of Goldman Sachs and JPMorgan Chase. Neither firm elected to comment on this move. Another encouraging development comes from Providence, R.I., where Mayor Angel Taveras asked a consultant to explore alternatives to the 15% allocation to hedge funds currently held by the Providence pension fund. As Mayor Taveras put it, “To me, it’s a question of whether we can get the same performance for less risk and fewer fees.” Our response would be that because you would pay lower fees, you would expect to achieve higher performance. Furthermore, the hidden risks of hedge funds such as leverage and exposure to derivatives may render them inappropriate for funds held in the public trust. Meanwhile, according to the authors of the Wall Street Journal article cited below, the investment staff of CalPERS expressed “low conviction” that hedge funds should play “an important part of CalPERS strategy”. Unfortunately, the staff members surveyed do not control the processes of asset allocation or manager selection.

Although CalPERS is several orders of magnitude larger than the Montgomery County pension fund, the gatekeepers should not hesitate to learn and implement the valuable lesson provided. Failure to do so may prompt a taxpayer’s revolt, and rightfully so. We at IFA will continue to hold their feet to the fire.


1Michael Corkery and Kirsten Grind, “Pension Fund Takes Neighborly Advice”, Wall Street Journal, June 20, 2013.