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New Study: MD Pensions Underperforming, Paying Billions in Fees to Wall Street

Via Meadia has argued that there is a perverse linkage between public sector unions, state pension funds, and Wall Street investment banking; a new study from two Maryland think tanks confirms it, finding that not only are state pension funds grossly underperforming, but much of the returns are also going to Wall Street firms rather than pensioners:

According to the findings, state public pension funds spent over $7.8 billion in fees last year alone—a 15-percent increase over three years—despite the consistent failure of money managers to hit target returns or outperform passive equity index funds, which charge lower fees.

“The vast majority of public pension systems in the United States contract with Wall Street firms to select the publicly traded stocks and bonds that comprise the bulk of the systems’ investment portfolios,” says the study. “The firms’ typical ‘sales pitch’ is that they can ‘outperform’ a given section of the stock or bond market; therefore, the system should pay them a fee for their stock — or bond — picking prowess.”

Over the last 10 years, annual returns for large public funds averaged 5.9 percent versus expected target returns of 7 to 8 percent, according to the report. […]

With the average Wall Street fee ratio of 0.41 percent paid by state pension systems, nearly half of those returns were eaten by the fees.

The story is always the same. Public sector unions press for fat pension promises. Politicians cave, but refuse to raise taxes or cut spending to pay for their promises, instead assuming high rates of return to keep up the fiction that workers’ pensions are secure. Pension fund managers chase high returns from aggressive and risky investments—exactly the kinds for which Wall Street management firms can charge the highest fees. True blue Democrats thus piously denounce Wall Street while simultaneously feeding the beast.

Unions, politicians, Wall Street: all are in it together. The victims are the very workers and taxpayers they claim to support.

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  • Bruno Behrend

    I’m reading “The Death of Capital,” by Michael Levitt. It discusses at length the legalized corruption of Private Equity funds.

    If there is one area where the “free market”
    movement has made mistakes, it has been the unnecessary and damaging deregulation of an industry whose history deserves nothing but intense oversight.

    Giving a powerful, wealthy, and borderline sociopathic industry the power to “self-regulate” is insane.

    This is not to say all regulation is good. Dodd-Frank is illustrative of just how dangerous and awful regulation can be. Financial regulation in the US is a primer for how powerful, competing factions make sure that only the worst laws get passed.

  • Chris Tobe

    Much of the losses and fees come from a rogue curreny manager. Record Currency charged Maryland over $53 million in fees while losing them over $350 million in FY 11

  • Daniel Messing

    Why don’t the pension funds insist that any to their advisers fee is paid only from the return that exceeds the return on an index fund (plus any fee that that fund charges)?

  • Jacksonian Libertarian

    I fail to see why Wall Street is always being blamed for doing exactly what they are asked to do. I blame all the leftist attacks by Obama and the Democrats on capitalism, for the meme that Banking Businesses are evil, when just like other businesses they are only looking to make a profit and stay in business. It seems to me that it is the Leftists that are refusing to take responsibility for their own policies that are truly at fault and that firing them in favor of fiscally responsible TEA Party leadership would solve the problem.

  • thibaud

    Maybe in future posts Mr Mead will try to grapple with the fact that deep “blue” heavily-interventionist Holland’s public pension funds are solvent.

    How can that be, Mr Mead? You insist that a “strong, well-funded state” inevitably leads to financial profligacy and insolvent pension.

    Perhaps you or your interns actually do a bit of, so to speak, RESEARCH into various nations’ pension fund management/governance, pension funding, taxation and statutory regulations before you opine again on this matter.

    Mead’s repeated posts on pension fund managers’ underperformance didn’t focus on “leakage,” ie the amount of underperformance due to hedgefund/PE managers’ absurdly one-sided fees, until certain commenters educated him on this.

    Better late than never. But it needs to be reinforced, with numbers and proper analysis of the sort that VM doesn’t do.

    Again, if a pension fund manager’s allocation to “alternative investments” (and other funds that use the typical 2-and-20, plus clawback only upon fund dissolution provisions) totals more than 50% of the total pension obligation, and if Simon Lack of JP Morgan is correct that 84% of the returns over time will be captured by the outsourced fund manager, then the amount of underperformance due to this “leakage” will equal or exceed 100 basis points each year.

    In other words, this payout imbalance, ie the scam perpetrated by Mitt Romney, Paulson and their ilk, ALONE accounts for the underperformance between Bill Gross’s 6.6% and the 7.5% needed to meet the fund’s obligations.

    In short, the Mitt Romney scammers are a large part of the problem in this country.

    Canadian funds, increasingly, bypass the Romney scammers entirely, managing their money in-house.

    But Canada has a “blue model”. Can’t have that in this country. We should ELECT the likes of Mitt Romney, not run him out of town.

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