The California Public Employees’ Retirement System (CalPERS) spent nearly $50M on their investment advisors in 2014, despite producing a dismal 2.4% investment return – 67% lower than what the market returned over the same time, as measured by the S&P 500. CalPERS’ 275 investment officers and portfolio managers cost taxpayers $49.27 million, with chief investment officer Theodore H Eliopoulos’ $856,000 compensation package topping the list.
The California State Teachers’ Retirement System (CalSTRS) also missed its 7.5% target, returning only 4.8%, but spent significantly less on their investment advisors in the process. CalSTRS spent roughly $18 million on their 100-plus investment officers and portfolio managers. Their chief investment officer, Christopher J Ailman, received a $674,000 compensation package.
To put these returns in perspective, an index fund that tracks the Dow Jones Industrial Average (DJIA) returned 7.1% and the S&P 500 fund returned 7.4%.
After adjusting the total cost spent on investment advisors against actual investment results, CalPERS’ performance looks even bleaker. CalSTRS spent roughly $3.75 million per percentage point of returns on investment advisors, whereas CalPERS spent nearly six times as much at over $20 million per point. These costs are only for employees of their respective retirement system and do not include the billions of dollars spent on fees for external funds and the unknown carried interest fees associated with CalPERS’ private equity investments.
One of the added benefits of utilizing the appropriate, lower discount rate in the 4-5% range is that public pension funds would be able to save billions of dollars on fees. For example, the New York Times reported that CalPERS paid $1.6 billion in fees to external funds managing their global equity portfolio in 2014. By contrast, the comparable fees for investing in the S&P 500 index ETF would have been $154 million, for a savings of nearly $1.5 billion.
Naturally, given the size and current investment objectives of both CalPERS and CalSTRS, investing in a single index fund is implausible. Yet, it does illustrate the degree of savings that would come from using a risk-free discount rate in which long-term AA-rated bonds and a basket of index funds were used in lieu of an aggressive investment strategy and the fees that accompany it.
The argument against such a conservative strategy is that it would reduce the potential for investment gains that a more aggressive strategy would provide. Yet, neither CalPERS nor CalSTRS has been able to beat the market over the past 20 years, despite spending millions of dollars each year on investment advisors, at taxpayer expense.
While both CalPERS and CalSTRS tout their 7.8% returns over the past 20 years as being indicative of their investing prowess, this is significantly less than the 9% achieved via an index fund that tracks the S&P 500. As such, it is hard to justify the millions spent on investment advisors internally, not to mention the billions spent on investment fees externally.
Many defenders of the status quo attempt to impugn the motives of those advocating for pension reform as being de facto lobbyists for big bankers and investment managers on Wall Street, claiming that a shift to defined contribution plans would line the pockets of fund managers on Wall Street. In reality, California’s public pension systems consistently send billions of dollars each and every year in fees to Wall Street.
A shift to a defined contribution plan would give individuals greater access over their own accounts and dramatically reduce the fees being paid to Wall Street, as individual investors are free to choose low-cost mutual funds or exchange-traded funds (ETFs) that have dramatically lower fee structures than what CalPERS and CalSTRS pay, yet have outperformed both pension funds over the past 20 years.
Robert Fellner is the Director of Transparency Research at the California Policy Center.