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NYC Kicks Pension Fees to Wall Street

Like many cities around the country, New York City has backed itself into a corner where it is relying on a high rate of return to keep its pension plan healthy, and is turning to Wall Street to help boost the performance of its investments. Despite the fact that using outside managers hasn’t been shown to significantly boost fund performance, this management doesn’t come cheap: Bloomberg Businessweek reports that the city is currently paying $472.5 million in Wall Street fees, up 28 percent from last year and far higher than the $280 million the city paid less than a decade ago:

The growing cost underscores the challenge Stringer and municipal officials across the U.S. face in reducing pension-management fees and boosting returns as the gap between promises to retirees and the assets they have to pay for them has widened to $1 trillion, according to data compiled by Bloomberg. New York’s funding deficit alone totals $72 billion.

To help shore up their funding, retirement systems such as New York’s have turned to riskier and more expensive asset classes, such as private equity, hedge funds and real estate, to hit targeted annual returns of 7 percent to 8 percent. Money managers of those funds typically charge 2 percent of assets they oversee, plus 20 percent of profits, which is higher than traditional stock and bond funds.

The city’s new comptroller claims to be serious about reducing the amount the fund pays in fees and possibly managing more of the funds in-house. This is a good idea, but it will likely take more than that to solve the problem, which lies more with the funds themselves than with their management. The truth is that New York’s investment return targets, at somewhere between 7 and 8 percent, are probably too optimistic. Unfortunately, it’s difficult to scale these targets back without asking taxpayers to put more money into the fund or asking pensioners to accept lower benefits, neither of which is likely to be particularly popular.

[Scott Stringer photo courtesy of Getty Images]

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  • wigwag

    A school child should be able to obtain an average annual return of 7-8 percent. Most university endowment funds routinely do far better than that as long as the time frame your measuring is not unduly short. Few high net worth individuals have portfolios that don’t achieve that level of return either.

    Here is the inflation adjusted rate of return of the S&P 500 for every decade since the 1950s.

    1950s: 16.7%
    1960s: 5.2%
    1970s: -1.4%
    1980s: 11.6%
    1990s: 14.7%
    2000s: -3.4%
    2010-: 48.0%

    There are surely a lot of dumb hedge fund managers out there, but any investment advisor worth his salt should easily be able to attain an inflation adjusted return of 7 percent.

    Often pension funds do stupid things like invest in “socially responsible” projects that are sure losers. On the other hand, investing pension funds as conservatively as Professor Mead recommends isn’t prudent or conservative, it’s dumb.

    By the way, according to almost every indicator New York City pension funds are adequately funded at current levels. By every indicator, New York State pension funds are fully funded and perhaps too fully funded (which means benefits can be safely increased). The only state pension fund in the United States even healthier than New York’s belongs to Washington, D.C.

    Last I looked, New York and D.C. are pretty “blue.”

    The retired employees collecting pensions from these well funded plans should consider themselves pretty lucky that no one is looking to Walter Russell Mead for investment advice.

    • Andrew Allison

      The subject of the Quick Take was the exorbitant fees which the city is paying for exotic investments. As your data show, an S&P Index fund would get the job done at an order of magnitude lower cost to the pension fund.

      • wigwag

        Whether fees that “seem” exorbitant are truly exorbitant is defined purely by the return the manager is able to achieve measured over a reasonable time horizon.

        Whether an investment is “exotic” depends on your point of view. If the portfolio is large enough and well-diversified enough there is room for investments that non-experts might consider exotic. Of course there are circumstances where these kinds of investments should be eschewed.

        While few equity mutual funds available to the general public are able to consistently beat the S&P benchmark, numerous hedge funds are able to accomplish the feat for extended periods of time.

        It would be the opposite of prudent for portfolio manager of a well run pension fund to exclude these investments simply because the fees are high or, to the public,, the nature of the investment seems exotic.

        The well capitalized funds of New York City and the extraordinarily well capitalized funds of New York State are precisely the types of funds that should consider these investments.

        Less well capitalized funds probably shouldn’t.

        Howard Stringer (who defeated Eliot Spitzer) seems like a good man. I bet he will get it figured out.

        • Andrew Allison

          What, exactly, did the city’s pension fund get for the $472.5 million dollars in fees, on which it would have earned 48% if the money had been in an S&P 500 index fund?

          • wigwag

            I can’t answer your question completely because I simply don’t know the details of the city’s pension performance over time. It is all public information though and I bet that you can find it at the website of the New York City Comptroller (the office Stringer was just elected to).
            What I can tell you is that the five f

          • Andrew Allison

            With respect, if you wish to counter Mr Stringer’s and my argument that lining the pockets of Wall Street was not a good investment you, not I, need to support a counter-argument. A convincing one would run along the lines of: had the fund been invested in an S&P index fund for the past decade, the return would have been been 80%; the actual return achieved was xx%.

          • wigwag

            But I never said that I thought that Stringer was wrong. I simply said that I didn’t know. What I did say in my initial comment is that Professor Mead’s statement that,

            “New York’s investment return targets, at somewhere between 7 and 8 percent, are probably too optimistic”

            is probably wrong.

          • Andrew Allison

            What you wrote was, “It would be the opposite of prudent for the portfolio manager of a well
            run pension fund to exclude these investments simply because the fees
            are high or, to the public,, the nature of the investment seems exotic.” I argue that it is, in fact imprudent and invite you to prove your case.

  • Corlyss

    Wall Street ought to pack up, bull and street sign and all, and move to North Carolina where a lot of banks have set up housekeeping.

  • USNK2

    Fascinating to finally be learning Mayor Bloomberg’s legacy as a true tax-and-spend liberal (thanks for that retroactive water use fee to pay for the unnecessary and way over budget water filtration plant in addition to all the other tax increases to double per capita public school spending past twelve years) when so many NYC voters think Bloomberg is a “typical Republican”…
    I digress.
    May Scott Stringer find his inner fiscal conservative once Wall Street and Big Real Estate have their way with whatever remains of NYC.

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