Money management, according to billionaire hedge fund managers and other high-paying practitioners, is a complex science and art. But is it really necessary?
The big state pension funds in states like Pennsylvania or California spend hundreds of millions of dollars a year to hire lots of sophisticated advisers to gamble on obscure strategies – several categories of hedge funds and capital funds – investment, real estate and debt – hoping to stimulate long term profit and protection against market downturns. Over time, returns have fallen behind.
A few counties in Pennsylvania have found a simpler and better way, says Jim McMillin, comptroller-elect of Butler County from 1994 to 2014, and architect of that county’s pension investment strategy, which relies primarily on investments in low cost based on stocks and bonds. index, from Vanguard Group, based in Malvern.
Butler was “the first county in Pennsylvania to be fully indexed,” McMillin recalls. “We have reduced our fees by over $ 1 million per year, reduced our overall fund risk and consistently outperformed the vast majority of actively managed funds. Montgomery County made a similar change starting in 2013, a break so decisive that the county did not report profits until then.
McMillin points out that Pennsylvania’s largest pension fund, PSERS, which currently invests $ 73 billion for half a million active and retired public school employees, has raised more than $ 4 billion more over the ten years if he had invested like Butler County (and this is based on a conservative average of $ 50 billion for RSFP assets over those years.)
Butler’s financial reports show he averaged 8.08% annual returns over that decade, while PSERS – the retirement system for public school employees – averaged 8.0%, a small difference that adds up dramatically over time.
McMillin suspects the disparity is actually greater. Count him among the skeptics who suspect that returns are inflated on “esoteric” alternative investments that are privately held and cannot be easily sold. “I don’t know how to get fair market value on hedge funds and limited partnerships,” he said. “If this instrument does not trade in the market, the valuation is subjective.”
Last year, as stocks rebounded from pandemic lows, the PSERS returned 24.6%, breaking its own record. But Butler posted 26.8 percent, more than two percentage points higher.
Montgomery County, which switched to low-cost index funds from 2013, returned 26.5%, according to data from Montgomery CFO Dean J. Dortone.
After the stock market briefly lost nearly half of its value in late 2008, PSERS responded by reducing its holdings of US stocks and investing more in private funds, arguing that this would shield the fund from stock price volatility. while creating more value over time.
That’s when McMillin and his pension board – the county treasurer and elected commissioners – took a different approach. They asked its hired fund managers to more clearly disclose their investment results, net of fees, for each quarter.
They did not comply cheerfully. “It was an uphill battle,” he said, laughing at the idea that a public contractor would resist presenting his performances in an easy-to-read format.
But, he said, investment managers led by CS McKee, a well-connected Pittsburgh firm specializing in investments for county plans, ultimately presented their returns clearly as requested.
The pension plan’s trustees compared these results to broad stock and bond indices such as the S&P 500, staple benchmarks in the investment industry.
“It was a real eye-opener,” when they realized that private managers were far from the clues, says McMillin.
This sparked much debate as managers had “cultivated close ties with politicians in Butler County,” McMillin said, including in some cases direct campaign contributions to local races, or picking up notes. dinner and golf at investment events, before such contributions were effectively prohibited. by the SEC in 2010.
In the end, the board ordered what it now calls “a tectonic shift in our investment policy: virtually all of the fund’s $ 200 million in assets were transferred to Vanguard index funds – large cap, mid cap, small cap, international and fixed income “.
Measuring the difference “was not a Herculean task,” he adds. “This is how we migrated to indexing. It became clear that we were overwhelmed by fees and paying for active management that was underperforming. So they bought stock index funds instead, following specific investment baskets.
This was the opposite of a major strategy pursued by PSERS, with what are now called “private” investments: private equity, private real estate, private debt and a bewildering variety of hedge funds.
PSERS was an outlier among its peers for its low percentage of US equities. PSERS leaders feared that stocks would fall again, as they did in 2001 and 2008. He could not afford the risk of such large losses. Managers therefore bet that other investments would both pay more over time and decline less when markets were weak.
But instead, US stocks rose rapidly thanks to the Obama and Trump administrations, while hedge funds in particular failed to perform as expected. The strategy therefore pushed the returns of the PSERS well below US stock indices like the S&P 500.
The Butler reform was not quite complete. The majority of the board insisted on keeping about 10% of its money in a local last stock picker, McMillin said. This firm’s returns have consistently underperformed stock indexes and were closed last year, he said.
But the general results of Butler’s experiment are clear, McMillin said. Since the switch to index funds, Montgomery and Butler counties have outperformed the largest state fund, at a much lower percentage cost.
In the comparison he put together for The Inquirer, McMillin also included Westmoreland County in western Pennsylvania, whose plan, like those of most of the state’s 67 counties, is still invested in. a wider range of “active” investments. It is not surprising that its returns more closely follow those of the PSERS.
Can public funds learn from counties? New investment targets adopted by the PSERS board at its December meeting reduced the plan’s hedge fund target to zero, while nearly doubling dollars invested in stocks.
Some directors questioned if this is really the right time to buy more stocks after so many years of record performance and with returns that were squeezing inflation. Current and former state treasurers Stacy Garrity and Joe Torsella, who both sit on the PSERS board, have long advocated for a simpler investment strategy. They say it could take years to complete the switch from hedge funds to stocks. Maybe the stock market will be more attractive then.
This debate is not new. McMillin remembers how PSERS Board Chair Melva Vogler “gritted her teeth when I appeared” at state investment conferences in the early 2010s, “knowing full well the uncomfortable questions that I frequently asked the representatives of the PSERS ”.
The PSERS will not change overnight. After Chief Investment Officer James H. Grossman Jr. and Chief Executive Officer Glen Grell announced their departure late last year, directors will review a series of critical reports in 2022 that could affect how PSERS purchases securities. future investments. And this is in addition to ongoing investigations by the federal grand jury and the Securities and Exchange Commission into the practices of the PSERS, including how it exaggerated its investment returns and was forced to retract them.
McMillin also notes that the plans have different needs. Besides the much larger scale of statewide plans, county plans are better funded – they haven’t faced the gap between state funding and rising costs. retirement plan that opened up for statewide funds in the 2000s. With additional liquidity, county plans could better withstand a short-term decline in the value of investments, he said. he declares.
And McMillin said counties can certainly learn from some things the state’s plans are doing. For example, Inflation-Protected Treasury Securities (TIPS), the capital of which increases with inflation, are one of the most important investments held by the PSERS.
The Butler County Pension Board “abandoned the TIPS component of Vanguard” after he left office, as if inflation was no longer a concern, McMillin said. “They could probably use more now.”
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