Multiple Paths with Arrows

Pension-Gate: More Smart Advice from Maryland

Multiple Paths with Arrows

About a year ago, we called attention to a report by the Maryland Public Policy Institute and the Maryland Tax Education Foundation 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 of that report, Jeff Hooke and John J. Walters, have just issued a follow-up report, “Wall Street Fees, Investment Returns, Maryland and 49 Other State Pension Funds” that repeats the same advice but extends it to all fifty states. To this, we at Index Fund Advisors say, “Glad to have you on-board.” Hooke and Walters draw a straight line between fees paid to Wall Street and lower returns received:

State Pension Funds Fees and Returns as of 6/30/2012

 

Median Wall Street Fee Ratio

Annualized Five Year Return

Top Ten Wall Street Fee Ratio States

0.61%

1.34%

Bottom Ten Wall Street Fee Ratio States

0.22%

2.38%

Difference

0.39%

-1.04%

 

Overall, the authors calculated that over the last five years, the median state pension fund lagged a corresponding portfolio of index funds by about 0.7% per year. The majority of this difference is attributable to the higher costs of active management. The authors estimate that state pension funds could cut their costs by over 90% by switching from active management to simple index funds. This translates to annual savings of $6 billion which would reduce unfunded liabilities by about $80 billion. That’s real money, even by government standards.

The remainder of the report focuses on the state of Maryland, which unfortunately did not heed the advice given and so remains as one of the top ten Wall Street fee ratio states (0.64% annual fees) and has been punished with lower returns (0.78% for the five years ending 6/30/2012). Hopefully, the trustees and administrators of Maryland’s state pension fund will take a lesson from Montgomery County, Pennsylvania which just voted to transition its pension fund to index funds after a thoughtful presentation by John Bogle, the founder of Vanguard and the first retail index fund. For the record, Mr. Bogle has said that he is willing to meet with the gatekeepers of any state pension plan to discuss the merits of indexing, simply because it is the right thing to do for the taxpayers. We sincerely hope that he will complete a tour of all fifty state capitals, starting with Annapolis.