June 17th, 2015
by Elliott Morss, Morss Global Finance
Most of us have "earned" one or more pensions in our working lives. And they are important: the Fed estimates US pension assets at nearly $18 trillion. For US households, pension "claims" are almost $21 trillion, by far their largest financial asset. US pension management is a subset of the global financial industry, managing and earning fees on $55 trillion of "institutional" assets.
How do pensions decide what to invest in? Most have committees. These committees hire consultants to help them decide which managers to hire and what to invest in. Given this structure, there are two reasons you should keep an eye on how your pensions are being managed:
- Your pension committee gets sold "a bill of goods" by its consultants and/or
And there are plenty of examples of each.
Pension Committees Getting Sold "A Bill of Goods"
Every year, the investment consultants and managers come up with new investments slogans to keep their offerings "fresh". It reminds me a bit of the wine industry. A few years back, Richard Quandt wrote an enjoyable piece about terms used to describe wines:"On Wine Bullshit: Some New Software?". An analogy to the financial management industry is apt. The following table includes terms used by the "pension management salesmen" to market their products. All the terms come from "Pensions & Investments", an excellent source of information and thinking on the financial management industry. The table has three columns. The left hand column lists "sectors/categories" for investments. These became popular a couple of decades back when "asset allocation" was in vogue. The thinking was that an investor should allocate their assets among sectors. In the last five years, "alternative investments" (the middle column in the table) became the rage. And the right hand column provides a listing of terms used by different management companies to describe their strategies.
Table 1. - "BS" Terms Used in Financial Management
Source: Pensions & Investments
Now you might say I am being unfair to the financial management industry. Like other industries, they have to market their product and come up with new slogans every year. And furthermore, figuring out what these slogans mean and investing accordingly might generate exceptional returns. And finally, pension committee members probably know what is really going on. But do they?
Let's take these points in reverse order. Pensions & Investments lists pension committee requests for proposals from financial managers. Table 2 presents a few of them.
Table 2. - Pension Committee Manager Requests
Source: Pensions & Investments
I would love to have sat in on the committee meetings resulting in these selections. I can imagine the discussions:
- "I favor a long term distressed opportunities."
- "But what about international alpha tilts structured equity fund?"
- "We should probably have some of our assets invested in core-plus/value added real estate."
- "I don't like any of these. Market-neutral portable alpha sounds best to me."
If I appear cynical, it is because I am. A reading of Paul Samuelson and Burton Malkiel convinced me it is nearly impossible to outperform markets for any significant time period. They argued that most new information is discounted immediately in the stock market. So stock picking is a pretty random bet, unless you can get new information before anyone else. So suppose a "market-neutral portable alpha" scheme appears to work. As soon as word got out, everyone would soon use the strategy, thereby eliminating its competitive edge.
Let's look at some empirical data. Do such selections result in higher yields? Take the California Public Employees' Retirement Systems (CalPERS) as an example. With assets of $273 billion, it is second only to the Federal Retirement Thrift ($375 billion) in size among pension systems. It is huge: it recently announced that over next 5-10 years, it plans to cut back on the number of private equity companies it has invested in from 389 to 120! Probably a good idea. Easier to track what 120 private equity companies are doing than 389.
And with administrative expenses of somewhat under a half a billion dollars annually, CalPERS should be able separate "wheat from chaff" when it comes to investment advice. As Table 3 indicates, it has more than 16,000 investments.
Did the pensioners get their money's worth? What if instead of incurring a huge amount of investment management fees it had invested in a couple of indices? In an earlier piece, I found that for the period 2009 - 2013, CalPERS earned a compounded annual return of 7%. For that some period, the S&P 500 had an annual return of 11%. The pattern continued in 2014. CalPERS earned 18%, while the S&P 500 was up 23%. Would CalPERS have been better off slashing its administrative costs by investing in a small number of index funds? I think so.
As mentioned earlier, most pensions have committees that hire consultants to help them decide who manages their monies. One would be hard-pressed to devise a more inviting scheme for corruption: the consultants bribe pension committee members to agree with them and the consultants get paid by potential fund managers. Mostly, the corruption is not discovered. But it happens a lot.
And yes, it happened at CalPERS. A 17-month investigation found that Federico Buenrostro Jr. - along with former pension fund board members Charles Valdes and Kurato Shimada - strong-armed a benefits firm to pay more than $4 million in fees to consultant Alfred J.R. Villalobos, who later hired Buenrostro. Who was Buenrostro? The chief executive of CalPERS! In addition, he was charged with pressuring subordinates to invest billions of dollars of pension money with politically connected firms.
And then there was the case of Robert Citron, the Orange County, CA treasurer-tax collector whose bad investments ($1.6 billion lost) forced the county into bankruptcy back in 1994. In this case, it appears that both ignorance and corruption played roles. Citron claimed that brokers told the Times in 1997 that Merrill duped him into making risky investments. However, a grand jury later found that Citron had relied on a mail order astrologer and a psychic for interest rate predictions. Other Orange County officials faced criminal charges in the fallout from the bankruptcy.
I started this article urging you to "keep an eye on" your investments. What does that really mean? If you are fortunate enough to have some choice in how your pension monies are invested, try to find low-fee index funds for them. Failing that, Google the name of your pension manager every so often for "news."
 Paul A Samuelson, "Proof That Properly Anticipated Prices Fluctuate Randomly", Industrial Management Review, 6:2, 1965 (Spring) and Burton G. Malkiel, A Random Walk Down Wall Street, W.W Norton & Co., Inc., 2007.