Public pension funds have been saddled with billions of dollars in unreported performance fees as a result of their increasing reliance on equities and alternative investments, according to a report from the Pew Charitable Trusts.
In a move to boost investment returns, public pension funds have in recent decades moved away from low-risk, fixed-income investments, and have significantly increased their holdings of equities and alternative investments. According to the report, public pension funds have more than doubled their allocations to alternative investments in less than a decade – from an average of 11% of assets in 2006 to 25% in 2014.
The report said that accounting and disclosure practices among pension plans “have not kept pace with increasingly complex investments and fee structures, underscoring the need for additional public information on plan performance and attention to the effects of investment fees on plan health.”
According to the report, state and locally run retirement systems currently manage over $3.6 trillion in public pension fund investments. Approximately 50% of these assets are invested in stocks, 25% in bonds and cash, and another 25% in alternative investments, such as private equity, hedge funds, real estate, and commodities.
While the move toward more complex investment vehicles doesn’t guarantee a greater return, it does mean higher investment fees. Pew found that state funds paid more than $10 billion in fees and investment-related costs in 2014, which was their biggest expense. And as a percentage of assets, the fees have increased by approximately 30% over the past decade
There is “a uniform need for full disclosure on investment performance and fees,” said the report. “Full and accurate reporting of asset allocation, performance, and fee details is essential to determining public pension plans’ ability to pay promised retirement benefits.”
The report also found that U.S. public pension plans’ exposure to financial market uncertainty “has increased dramatically over the past 25 years.” Pew used equity risk premium, which is the difference between targeted rates of return and the yield on very low-risk investments, such as long-term U.S. government bonds, as a measure of uncertainty. According to the report, between 1992 and 2015, the expected equity risk premium for public funds more than quadrupled to more than 4% from less than 1%.
“Government sponsors should consider investment performance both in terms of long-term returns and cost predictability,” said the report. “From this perspective, many fund portfolios are highly correlated with the up-and-down swings of the stock market, and expose state budgets to considerable risk and uncertainty.”