Private equity investments continue to pose challenges for public pension plans
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Private equity investments continue to pose challenges for public pension plans

Ohio and Pennsylvania's teacher pension plans are paying high investment management fees for private equity assets that bring in lower investment returns than the rest of their portfolio.

For investment managers of public pension plans, the pressure to achieve high returns has increased in recent years. This is because, in part, pension systems have been slow to adjust investment assumptions to the lower-yield investment environment. Private equity investing, which public pensions hope will bring higher returns, has become more common in portfolios. However, this strategy comes with a higher level of investment volatility, higher investment fees, and a noted lack of transparency. Recent experiences in Pennsylvania and Ohio highlight some of the challenges that arise from the growing reliance on private equity and alternative investments.

The Pennsylvania Public School Employees’ Retirement System (PSERS), which serves the state’s teachers and school workers, is leaning on alternative investments at a much higher rate than most state plans. PSERS invested 62.6% of its assets in alternatives like real estate and private equity over the last decade. For context, the average pension plan invests about 20% of its assets into alternatives. Pension Integrity Project analysis of PSERS portfolio performance has indicated that this asset class has underperformed relative to hypothetical passive index fund investment. Despite the focus on alternative assets, our policy analysts found:  

“For the last five fiscal years, PSERS only outperformed Vanguard’s basic 60/40 stock-bond portfolio (VBIAX), net retail investor fees, once.”

Private equity investments lack transparency and are difficult to value. As opposed to publicly traded securities, limited partnerships used by private equity managers can’t provide frequent performance updates and, as a result, advise stakeholders after the end of each fiscal year. This leads to a lag in reporting important details. Moreover, shares of companies owned by private equity funds are not publicly traded, meaning that their values can only be estimated, which is subject to potential bias. Private equity firms are also not obligated by the law to publish their lists of assets in accordance with Securities and Exchange Commission rules. While this information can be found on Bloomberg Professional Terminal, it is not available to the general public. This lack of transparency should be concerning to employees and retirees who rely on these funds and taxpayers who contribute to them.    

For the Pennsylvania teacher system, the management fees associated with private equity investments that the plan had to pay over the past four years ($4.3 billion) are more than the total amount members paid into the plan during the same time ($4.2 billion). The pension plan recently announced that member contributions will have to be raised going forward because of long-term investment results below the plan’s benchmark. As a point of comparison, the New York State Teachers’ Retirement System, which has double the assets of PSERS, reported 36% less in total investment fees and expenses than PSERS.

Pennsylvania’s teacher retirement fund isn’t the only public pension to come under scrutiny because of private equity investment this year. When Ohio’s teacher pension eliminated an annual cost-of-living increase in 2017, it caused legislators, retirees, and plan members to pay greater attention to the fund’s investment transparency and the fees paid to private equity fund managers. The State Teachers Retirement System of Ohio (STRS), which has over 18% in alternative investments, has been paying about $303 million, or 0.40% of the assets the plan held in 2018, in fees associated with active investments in private equity and hedge funds. Reason’s senior policy analyst Marc Joffe found that:

“In Ohio, all five state pension plans tracked by the state’s Retirement Study Council reported returns on domestic public equities substantially exceeded their private equity returns.”

Pension funds shouldn’t rely on alternatives investment as a tool that will single-handedly save pension plans from investment returns below plan expectations. The race for higher returns can jeopardize the fiscal health of a pension plan and the financial future of the plan members. Coupled with high management fees, alternative asset investments are proving to be a risky gambit for most plans that are already seriously underfunded.

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