Why New York City's Pension Funds Fall Short of Market Gains
By: John Carney | Senior Editor, CNBC.com
Susan Edleman at the New York Post reports that New York City taxpayers will have to pony up more than $1.5 billion because public pension-fund investments failed to meet their statutory goal of 8 percent gains.
That's bad news for taxpayers. But it's important to understand that the failure to meet the 8 percent goal in any given year is not a scandal—and certainly not a black mark on the record of City Comptroller John Liu.
Pension funds are meant to have investment portfolios that are less risky than the market overall. They are supposed to more prudent than the market is on average, which usually means that returns should be lower than the market average. Even if New York City's pension funds were run by the world's most amazing Alpha-producing asset managers, their absolute returns should be less than, say, the return on the S&P, since they are taking less risk than other funds.
The average annual return on the S&P from 1926 to 2011 was 9.77 percent. Yet most pension funds calculate their average annual return at just 8 percent—which is why they set that as their annual goal. At least part of that difference should be the result of pension funds seeking to be less risky than the S&P.
When Treasury bonds and highly-rated corporate bonds are at historic lows, and the S&P gains just 3.4 percent, an overall gain of 1.37 percent isn't bad. (The numbers here are for fiscal year 2012, which ended June 30.)
Which is why it's ridiculous that John Murphy, a former executive director of the city's largest pension fund complains, "If you do worse than the stock market, something's wrong."
Beating the market is hard. It's not something we should want pension funds to aim at—it would almost certainly mean they are taking on more risk than they should. It's certainly not something we should expect.
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