Higher Fees Are Fruitless for Pension Funds, Think Tank Says

The Maryland Public Policy Institute has released a study critiquing active management in all forms—during the post-Crisis bull market, at least.

It’s the oldest story in the book: Pension funds are paying too much to Wall Street—or so says one think tank, at least.

According to a new study by conservative Maryland Public Policy Institute (MPPI), state pension funds that paid the highest in fees recorded inferior average returns than those with the lowest fees over five years ending June 30, 2014—a period that encompasses one of the strongest bull markets in history.

Specifically, the 10 states writing the biggest checks to Wall Street managers earned annualized five-year returns of 12.44% over this timeframe, the report said. This falls behind the 12.77% net-of-fees returns at the 10 funds paying lower fees.

“The investment policies suggest either a lack of numeracy or a decision process not driven by the best interests of the pensioners and taxpayers,” said Jeff Hooke, a fellow at MPPI. 

MPPI chartSource: Maryland Public Policy InstituteStill, the institute found 33 state funds surveyed paid $6 billion in fees over the last fiscal year.

The report claimed a majority of public money managers consistently underperformed benchmarks over the same five-year period.

Some 84% of domestic equity funds and 73% of managed fixed income funds fell short of their benchmarks, proving that pension funds are “paying sizeable fees for the privilege and bearing substantial transaction costs” for the index.

Alternatives managers also disappointed, the report said, with state pensions’ hedge fund performance trailing behind a passive index by 635 basis points net of fees over the five years ending June 30, 2014.

Private equity returns also underperformed the S&P 500-plus-3% benchmark by 511 basis points net of fees, MPPI found.

“This is not a glowing endorsement for Wall Street advice, reminding one of author Fred Schwed Jr.’s critique of Wall Street, when he asked, ‘Where are the customers’ yachts?’” the report said.

These sentiments and figures reflect state pension funds’ recent moves to shake up the fee status quo.

In April, New York City Comptroller Scott Stringer released an analysis of historical performance data for the city’s $160 billion pension system. Its findings showed manager performance was $2.5 billion below benchmark over 10 years.

“This is not a glowing endorsement for Wall Street advice, reminding one of author Fred Schwed Jr.’s critique of Wall Street, when he asked, ‘Where are the customers’ yachts?’”“Right now, heads or tails, Wall Street wins,” Stringer said.

In addition, private equity, hedge funds, and real estate managers fell $2.6 billion short of target benchmarks after fees. Managers of public asset classes also “gobbled up” more than 95% of the value added, the analysis found.

America’s largest pension fund, the California Public Employees’ Retirement System, also announced in April it had cut expenses by $90 million over five years by bringing more management in-house and increasing its use of index strategies.

The think tank said state funds should embrace this passive approach for most of their portfolios to see both outperformance and lower costs.

According to the study, an index that mimics a typical pension fund allocation outperformed the peer group median by 1.62% annually over a five-year period—and cost a fraction of fees paid to external managers.

This option could save the 33 surveyed funds $5 billion in fees annually, MPPI said, potentially reducing unfunded pension liabilities by $70 billion within two years.

However, investors may not be all that interested in the all-passive, cheaper alternative, according to eVestment’s June report.

The data firm found investors are willing to pay more—but only for peer-topping past performance. Products with top-decile returns over a three-year period were 42% more likely to win mandates than their bottom-decile counterparts.

Furthermore, more than half (57%) of assets won in 2014 charged fees in the top 50%, the report said.

Related: State Pensions Demand SEC Action on PE Fees; When are High Management Fees Worth It?; New Jersey Pensions to Scrutinize Fees; NYC Comptroller Vows to Shake Up Wall St ‘Status Quo’

By Sage Um