The State Worker

Chasing higher returns, public pension funds spent $10 billion on investment fees in 2014

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CalPERS tries to make a splash with water bank investment north of Los Angeles.
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CalPERS tries to make a splash with water bank investment north of Los Angeles.

State pension funds across the nation shelled out more than $10 billion in fees in 2014 as they chased higher returns from increasingly complex and risky investments, according to a new report from the PEW Charitable Trusts.

The report traces 10 years of performance at the 73 largest state-sponsored pension funds. Collectively, they manage more than $2.8 trillion in assets.

Most of them, including California’s two major public employee pension funds, did not hit their target investment returns over the decade that PEW studied, 2006-2015.

Both California plans, the California Public Employees’ Retirement System and the California State Teachers’ Retirement System, sought to earn an average return of 7.5 percent. CalPERS brought in 6.2 percent over the decade, while CalSTRS earned 7 percent.

Both funds recently have dropped their target returns to 7 percent, acknowledging that they anticipate earning less money from investments in coming years.

The report’s authors wrote that many funds increased their use of so-called alternative assets, such as private equity, hedge funds and real estate over the decade. As a result, spending on investment fees climbed by at least 30 percent.

That figure does not account for about $4 billion in additional rewards that pension funds paid to investment partners in 2014. As a result, PEW suggested that the funds actually spent $14 billion on investment fees that year.

Alternative investments are attractive to large pension systems because many are badly underfunded. According to PEW, most have about 60 percent of the assets they’d need if they had to pay all of the benefits they owe today.

CalPERS and CalSTRS are within that range, with each holding about 64 percent of the assets they’d need to pay out all of their benefits.

“Greater investment in equities and alternatives can provide higher financial returns but also bring heightened volatility and risk of shortfalls. Most funds exceeded their investment return targets during the bull market of the 1990s but then suffered losses during the volatile financial markets of the 2000s – leading to higher pension costs for state and local budgets,” the report says.

PEW credits California’s two major public employee pension funds with having comparably transparent policies in disclosing the full costs of their investments.

CalPERS in the budget year that ended in June 2015 spent $1 billion on investment expenses. It paid an additional $700 million in performance rewards to its partners in profit-sharing agreements, according to the PEW report. CalPERS earned $4.1 billion from those deals.

CalPERS in the past two years has stepped away from some of the alternative investments that PEW studied. CalPERS has closed its hedge fund unit. It also reduced its stake in private equity. In 2014, CalPERS paid as many as 300 external investment fund managers. Today, it has about 150, CalPERS Chief Operating Investment Officer Wylie Tollette told The Sacramento Bee Editorial Board this week.

Adam Ashton: 916-321-1063, @Adam_Ashton. Sign up for state worker news alerts at sacbee.com/newsletters.

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