The city of Atlanta’s pension plans have paid millions of dollars annually to money managers who produced about the same results as those obtained from low-cost index funds, recent reports show.
Under pressure from last year’s sweeping retirement plan overhaul, pension officials have been making changes to cut investment costs and boost expected investment profits at the pension plans, which are underfunded by roughly $1.1 billion.
To eventually pay off that gap, which once totaled $1.5 billion and was eating 20 percent of the city’s budget, the city retooled the plans last summer to increase employees’ share of the pension costs, and to reduce newer hires’ future retirement benefits.
Currently, some employees contribute up to 13 percent of their pay to the pension plans.
But one part of last year’s pension reform could raise those contributions by up to 5 percentage points — to as much as 18 percent of pay for some employees — if the pension plans’ investments don’t do well over the long haul.
The city has three separate pension plans for police, firefighters and other employees, covering 5,600 employees and 6,100 retirees and other beneficiaries. The three pension plans, which have combined assets of about $2 billion, are overseen by three boards of trustees comprised of employees, city officials and council members.
Last year, the city’s three pension plans’ overall investment returns ranged from 1.02 percent at the general employees’ fund, the city’s largest fund, to 2.80 percent at the firefighters’ fund. Such results are little different than last year’s paltry returns in the overall market, or those of the pension funds’ benchmarks.
So far, the pension plans’ financial condition isn’t expected to trigger higher contributions, said Jim Beard, the city’s chief financial officer.
Contributions, fees, more
Ken Allen, president of the Atlanta police officers’ union, likewise said he’s confident the pension plans won’t need the much bigger contributions.
“For that to get to that impasse, we would have to get a complete decimation of the economy again,” he said.
Still, the pension plans’ performance — and their boards’ — “is going to have to be monitored closely,” Allen said.
Indeed, last year’s overhaul has forced the pension boards to make changes in how they run the pension plans, said Beard.
Such moves included investing more money in stocks to boost expected returns, and shifting some funds to lower-cost alternatives, such as so-called “index” funds. Index funds are less expensive to run because they simply try to mirror a broad market index by holding the same stocks or bonds.
But so far, those efforts are at an early stage, and haven’t dramatically changed the pension plans’ results.
The pension plans’ investment management fees totaled $8.5 million in 2011. To be sure, such costs amount to a tiny percentage — less than 0.5 percent — of the pension plan’s total assets, and are dwarfed by the other challenges faced by the plans.
Still, the investment costs matter over time, especially when investment returns are low.
Last year, the three pension funds’ long-term returns over the past decade ranged from an annual average of 5.02 percent at the general employees’ fund to 5.52 percent at the firefighters’ fund.
All three plans’ performance is still far behind the 7.75-8 percent average return targets they must achieve over the long haul to meet their long-term promises to retirees and employees.
Like most pension plans — and most folks’ 401(k) retirement plans — Atlanta’s pension plans have to make up a lot of lost ground because their investments were ravaged during the financial markets’ crash in 2007-2009.
Such investment returns — and the fees paid to money managers year after to year to achieve them — also matter because the city’s sweeping pension overhaul hangs on meeting its investment targets over the long term.
The rescue plan assumes that the police and firefighters’ pension plans will, on average, have annual investment returns of 7.75 percent and the general plan will have 8 percent returns over the next 30 years. That’s well above the 6.75 percent returns that typical private pension plans assume.
Beard said last year’s pension overhaul — especially the provision that could boost employee contributions if the plans fall deeper in the hole financially — are spurring the pension boards to improve investment practices.
“They’re forced to assume more risk” to shoot for higher returns, said Beard, who also sits on the pension boards. Too much reliance on low-risk investments would produce too-low returns, he added, forcing the city and employees to chip in more money to the pension plans.
For instance, in mid-2010, the General Employees Pension Plan had only 46 percent of its money in stocks, which have higher risk but also higher expected returns than alternatives such as bonds and money market funds.
But by the end of 2011, the pension plan had boosted its stock investments to almost 72 percent of its $990 million fund.
Also, partially to reduce costs, the same pension plan shifted about $137 million, or almost 14 percent of its portfolio, late last year to one of Vanguard’s index funds, the S&P 500 Index Fund.
The other two pension plans already had higher stock allocations than the general pension plan.
The firefighters plan, which has $479 million in assets, also had already moved about a fourth of its money to index funds about three years ago.
Index vs. active
Some investment experts say such index funds, which simply try to mimic a broad market index like the Standard & Poor’s 500 stock index, are a cheaper alternative to so-called “active” managers.
The latter try to beat their investment benchmarks by doing a better job of picking or avoiding stocks, but usually charge higher fees and often don’t beat their benchmarks.
For instance, Vanguard’s index fund charges Atlanta’s general employee pension plan a fee of 0.04 percent of the $137 million it manages, or roughly $55,000 a year.
On the other hand, GLOBALT Investments is an Atlanta-based firm that actively manages about $65 million worth of stocks against the same benchmark for the pension plan. It charges fees ranging from 0.6 percent for the first $10 million down to 0.2 percent when the total assets top $100 million. At the Atlanta general employees pension plan, that works out to roughly $265,000 a year to manage half as much money as Vanguard’s allocation.
After fees, the Vanguard fund had an 11.81 percent return in the final quarter of 2011, when it was added to the pension plan. By contrast, GLOBALT’s return was 9.28 percent.
One expert who was involved with the Atlanta pension plan’s overhaul efforts suggested that the city’s pension plans rely too much on active money managers. As a result, its investment costs are high for the results that the money managers are producing.
“One issue is that Atlanta paid for active management, but they got an indexed result,” said John Mellott, a former Atlanta Journal-Constitution publisher who chaired the city’s pension reform panel. “If they had put this money in index funds, they would have saved $5 million or $6 million a year.”
Compounded over time, those costs add up to hundreds of millions of dollars, he said.
Beard said he has approached the pension plans’ money managers to negotiate lower fees. But he added that he still favors using a mix of both index funds, which can lower costs, and active managers, who can shoot for higher returns.
“If I think I have a fleet of [active] managers that outperform ... it may be worth paying to get that,” he said.
Atlanta’s pension plans
The city’s pension plans pay millions a year to money managers to beat their targeted returns, but often they don’t. Below are asset values and average annual return figures as of year-end 2011. The pension plans need to earn long-term returns averaging up to 8 percent a year to meet their obligations.
• Pension plan: General employees
• Assets: $989.6 million
• 1-year return: 1.02 percent
• 3 years: 10.87 percent
• 10 years: 5.02 percent
• Benchmark return (1 year): 2.43 percent
• Benchmark return (3 years): 12.08 percent
• Benchmark return (10 years): 5.00 percent
• Pension plan: Police officers
• Assets: $683.8 million
• 1-year return: 1.42 percent
• 3 years: 10.76 percent
• 10 years: 5.16 percent
• Benchmark return (1 year): 1.47 percent
• Benchmark return (3 years): 12.68 percent
• Benchmark return (10 years): 5.82 percent
• Pension plan: Firefighters
• Assets: $479.1 million
• 1-year return: 2.80 percent
• 3 years: 13.51 percent
• 10 years: 5.52 percent
• Benchmark return (1 year): 1.47 percent
• Benchmark return (3 years): 11.98 percent
• Benchmark return (10 years): 5.67 percent
Sources: Gray & Co.; City of Atlanta
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