A recent report by the Maryland Public Policy Institute examines the relationship between Wall Street fees and investment performance for 33 state pension funds over the last five fiscal years. The report finds that pension funds that pay higher fees tend to earn worse investment returns. Specifically, the top 10 states in terms of fees underperform the bottom 10 by 26 basis points in the median annualized five-year return.
This result sheds doubt on the ability of active money managers to achieve superior returns for pension funds. In fact, the report also shows that passive investing by indexing, with considerably lower fees, would have outperformed the median state pension fund by a significant margin. An index portfolio that mimics the asset allocation of the typical state pension fund would have earned a five-year net annualized return of 14.45 percent, which is 1.62 percent higher than the median net return for the 33 state pension funds. Indexing most of those funds’ portfolios would save those state plans about $5 billion a year, equivalent to a reduction in unfunded liability of $70 billion.
Despite the high costs and inferior performance, active management is popular among state pension plans due to irrational optimism and entrenched interests.
To read the full report, go here.