Georgia’s two largest public pension plans are managed by an in-house staff of 52 people, some of whom are paid far more than the governor.
Yet the plans might have generated better returns over the past decade by following many individual investors’ lead — putting their money into so-called index funds.
The state pension funds have earned about $1 billion less since 2005 on managed investments than if they had opted for index funds that simply track the broader markets, according to an Atlanta Journal-Constitution analysis based on the plans’ publicly reported data.
The pensions hold more than $80 billion on behalf of 600,000-plus state and school employees and retirees. Returns on investment don’t change the amount pensioners receive, but they do affect the overall health of the plans, which is measured by how much money they have to meet future obligations.
Officials with the Georgia plans say the investment information reported publicly doesn’t show the full picture, which they say is rosier. The Georgia plans’ returns have been similar to those in other states, and their costs are lower than average.
But most state pensions, including Georgia’s, could have done a lot better by replacing their active money managers with index funds, some experts say.
Unlike millions of individual investors, public pensions until recently have been slow to make that shift into “passive” or index funds. Studies show these funds have lower costs and usually outperform s0-called “active” managers who try to boost returns through astute stock-picking and other strategies. Index funds, on the other hand, aim to keep costs low and match the performance of broad market indexes such as the Standard & Poor’s 500 index by simply holding the same securities as the index.
Cost and performance issues matter because schools, state agencies, employees and taxpayers ultimately back the state-run pensions’ promises. The agencies owe decades worth of monthly pension checks to current and future retirees. Those are paid out of the pensions’ investment earnings, plus contributions from employers and workers’ payroll deductions.
More indexes
Recently, more pensions have been turning to index investing, but Georgia’s continue to rely on stock-pickers and other active strategies, and they have replaced many of their outside money management firms with in-house staff.
Together, the pensions’ outside and in-house money managers cost almost $62 million last fiscal year. The pension system chief investment officer, was paid $720,883 last year, while the next two top investment officers were each paid $544,305. The median pay for in-house investment staff was $144,000 last year, exceeding Gov. Nathan Deal’s $139,339.
Both the Employees Retirement System and the Teachers Retirement System are under-funded by billions of dollars. If they gap doesn’t narrow over time, it will eventually force tough decisions about benefits, payroll contributions or both.
The two pension funds dispute the AJC’s analysis indicating a $1 billion-plus shortfall in investment performance, which was based on returns and benchmarks disclosed in their annual reports.
On the contrary, they said their money managers have added almost $1.2 billion in “excess” earnings over the past 11 years, based on internal targets that better match the pensions’ portfolios than the measures included in annual reports.
Those reports use the better-known S&P 500 and a domestic bond index as their benchmarks. Many index funds replicate those benchmarks.
ERS and TRS fell short of the S&P 500 return — and similar index funds’ nearly identical returns — by more than 1 percent in their most recent fiscal year. They also undershot the bond index by a similar margin.
A 1 percent shortfall doesn’t sound like much, but it adds up when you’re managing more than $80 billion.
‘Widely recognized’
ERS and TRS use those indices in the public reports because they’re “widely recognized,” said Thomas Horkin, the state pension system’s assistant chief investment officer. But they don’t reflect the pension plans’ more complex mix of U.S. and international stocks, bonds and other investments, he said.
In a 2013 study, the Maryland Public Policy Institute concluded that most state pensions could cut their investment management costs by roughly 90 percent, to a mere 0.03 percent of assets, compared to 0.39 percent at the typical state pension.
“By indexing most of their portfolios, we conclude the 46 state funds surveyed could save $6 billion in fees annually,” the institute said, potentially helping the pensions to reverse their funding gaps.
In Georgia’s case, its investment costs — 0.075 percent of assets — are much lower than most state pensions. But a move to index funds still could save about $37 million a year, according to the AJC’s calculations.
Georgia’s pension officials say current state law doesn’t allow them to directly invest in mutual funds like index funds. But the state’s managers can duplicate the investments in index funds, potentially reducing costs.
In fact, other public and private pensions are now jumping into index investing.
Since 2012, the share of public pensions’ U.S. stock investments in passive index strategies has jumped from 38 percent to 56 percent, according to Greenwich Associates, in Stamford, Conn. The share has jumped from 33 percent to 48 percent at private pensions, the consulting firm said.
“We have not seen changes this large since we’ve been covering the institutional market,” said Andrew McCullum, managing director at Greenwich.
It’s easy to see why it’s happening, he added: most active money managers have come up short lately, and pension officials have doubted whether they’re getting their money’s worth.
Timing matters
“I would view this as dissatisfaction with the success of their active managers,” he said, although he pointed out that in some years, most active managers do better than index funds.
That last happened in 2013, when 54 percent of all active managers of U.S. stock investment funds beat the Standard & Poor’s Composite 1500 index, according to an annual scorecard by S&P Dow Jones Indices. Last year, on the other hand, more than 87 percent fell short.
In almost all investment categories, active managers under-performed more years than not, according to S&P Dow Jones Indices’ most recent scorecard, which goes back to 2000.
Georgia’s pensions have responded to outside managers’ high costs by shifting more money, duties and jobs to their in-house investment office over the years. Outside firms now manage about 13 percent of the pensions’ money, down from 50 percent a dozen years ago.
“We’re always looking for (outside managers) that we think might add value, but it’s hard,” said Horkin of the state pension system. “We’ve found that we can do as good a job internally.”
He added that “when you look at our investment expenses, I think we’re right in the ball park. We think our fees are cheap.”
But most public pensions have taken the opposite approach. They’ve turned 80 percent of their portfolios over to outside managers, said McCullum, at Greenwich.
