Risk not leading to reward for pension funds

Fees are on rise, but returns aren’t

Joseph A. Dear (right), chief investment officer for California’s pension system, said there were big differences in how various alternative investments performed during the financial crisis.

NEW YORK - Searching for higher returns to bridge looming shortfalls, public workers’ pension funds across the country are increasingly turning to riskier investments in private equity, real estate, and hedge funds.

But while their fees have soared, their returns have not. In fact, a number of retirement systems that have stuck with more traditional investments in stocks and bonds have performed better in recent years, for a fraction of the fees.

Consider the contrast between the state retirement fund for Pennsylvania and the one for Georgia.


The $26.3 billion Pennsylvania State Employees’ Retirement System has more than 46 percent of its assets in riskier alternatives, including nearly 400 private equity, venture capital, and real estate funds.

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The system paid about $1.35 billion in management fees in the past five years and reported a five-year annualized return of 3.6 percent. That is below the 8 percent target needed to meet its financing requirements, and it lags behind a 4.9 percent median return among public pension systems.

In Georgia, the $14.4 billion municipal retirement system, prohibited by law from investing in alternative investments, has earned 5.3 percent annually over the same time frame and paid about $54 million total in fees.

The two funds represent the extremes, with Pennsylvania in a group of pension systems with some of the highest percentages of investments in alternatives and Georgia in a group of 10 with some of the lowest, according to groupings of funds identified by the London-based research firm Preqin.

An analysis of the sampling presents an unflattering portrait of the alternative bets: The funds with small or even no positions in the riskier assets earned returns that were higher by more than 1 percentage point over the past five years, compared with returns by the funds with a third to more than half of their money in private equity, hedge funds, and real estate. Those funds with larger positions also paid nearly four times as much in fees.


While managers for the retirement systems say that a five-year period is not long enough to judge their success, those fees nevertheless add up to hundreds of millions of dollars each year for some of the country’s largest pension funds. The $51.4 billion Pennsylvania public schools pension system, for instance, which has 46 percent of its assets in alternatives, pays more than $500 million a year in fees. It has earned 3.9 percent annually since 2007.

Whether the higher fees charged by the alterative-investment firms are worth it has been hotly debated within the investment community for years. Do these investment entities, over an extended time, either offset the wild swings in assets during rough patches of the market or provide significantly higher gains than could be found in less-expensive bond and stock investments?

“We can’t put it in Treasury notes and bonds; that’s just not making any money,’’ said Sam Jordan, chief executive of the Austin Police Retirement System in Texas.

James Wilbanks, executive director of the Oklahoma Teachers Retirement System, which has largely stayed with stocks and bonds, said pension funds were obligated to take a cautious approach.

“We all heard the stories about institutional funds that had more than half of their assets in private equity in 2008’’ and then had to sell, he said.


The topic is taking on a sharper focus as more funds embrace the riskier strategy. By September 2011, retirement systems with more than $1 billion in assets had increased their stakes in real estate, private equity, and hedge funds to 19 percent, from 10.7 percent in 2007, according to the Wilshire Trust Universe Comparison Service.

Public retirement systems are struggling to earn sufficient returns with interest rates near record lows and more and more workers qualifying for retirement.

The costs of their pensions are growing fast, but state and local government returns are not keeping up.

A new study by the Government Accountability Office raised questions about how some alternatives performed for public and private pension funds during the financial crisis. Meanwhile, some public retirement systems that increased their stakes in alternatives are now trying to curb those costs.

Fees for the $242 billion in California’s giant pension system, known as CalPERS, nearly doubled to more than $1 billion a year after it increased its holdings in private assets and hedge funds to 26 percent of its total in 2010, from 16 percent in 2006.

CalPERS, which has earned 3.4 percent annually over the past five years, is pushing the managers of the funds for lower fees as well as reducing the number of outside managers it uses to try to bring costs down.

“I think it’s part of our job as public fund managers to do our best to drive a better bargain,’’ said Joseph A. Dear, the chief investment officer for CalPERS.

Dear cautioned that there were big differences in how various alternative investments performed during the financial crisis.

He said CalPERS’ investments in real estate had been “a disaster’’ and that its hedge fund investments had not met their benchmarks and were under review. But he said that its private equity holdings had easily beaten public stock returns over the past decade.