Europe News

US State Pension Funds Could Learn From the North

Gillian Tett, Financial Times

America’s public sector has not produced many pleasant financial surprises this year. This week, however, one emerged: John Liu, New York City Comptroller, announced that in the year to June 30, the City’s pension fund produced returns of more than 20 percent, raising total assets to $119 billion.

Admittedly, that level is only slightly higher than in June 2008, or just before the financial crunch. But it does, at least, mean that the losses of 2008 and 2009 have been erased.

Better still, Mr Liu is not the only comptroller with good news to share: this year a host of other public pension funds, like their corporate counterparts, have also produced large gains, as rising stock and bond prices have boosted asset values.

So far, so welcome. But before any politician – or pensioner – gets too excited, it is timely to ask some hard questions about how these state pension pots are managed.

For, there is a paradox hanging over America’s vast state pension sector. On paper, it would seem as if these giant funds should be bedrocks for America’s financial system.

They are not only crucial in policy terms, but vast in size: New York State, Texas and California all have pots worth more than $100 billion, giving them clout in the stock and bond markets, as well as in the private equity and hedge fund worlds.

But while these funds are vast, the system used to run this money is often antiquated. Most funds have asset allocation processes that are cumbersome, with money outsourced to numerous different managers; allocation decisions typically take between six and 18 months.

Some funds are run by political appointees, rather than investment professionals. And even when asset managers are hired, salaries for most senior managers range between $100,000 to $200,000, much less than in the private world.

That makes it hard to attract talent, let alone retain it. The result is that many state pension funds look like slow-moving, herbivorous dinosaurs, surrounded by financial velociraptors such as hedge funds and sell-side banks.

Little wonder that US public pension funds have underperformed most corporate funds in recent years.

And since the average returns for most public funds have been just 2-3 percent in the last decade, well below the 8 percent rate that many funds are obliged to pay out, places such as New York are being forced to pay hefty subsidies to plug that gap.

Is there any solution? One idea might be to look north. A decade ago, Canada used to run its public pension funds in a similar manner to the US.

However, since then, groups such as Ontario Teachers’ Funds and Canadian Pension Plan Investment Board have started managing large sums in-house.

They have also hired financial professionals on terms similar to private sector practices. Unsurprisingly, this has pushed pay higher.

The head of the Ontario fund collected C$3.92 million ($4.1 million) last year, while other executives got between C$1 million and C$3 million.

But fees paid to external groups have fallen too, and the reforms have boosted returns: Canadian funds earned 5-6 percent over the last decade, almost 300 basis points more than their US counterparts.

Could similar reforms be replicated in the US? It is hard to imagine right now. American voters are unlikely to back paying pension managers big salaries when wages are falling and pension benefits being cut.

Some states have suffered scandals in connection with the system used to allocate funds.

But while reform might be difficult, failure to reform could be costly too, for future pensioners.

Last year it was relatively easy for the funds to make money; rising markets tend to lift all boats.

But if markets get choppier, state funds will need to get more agile; otherwise, they risk being prey for financial velociraptors. Some public officials understand this well.

In New York, Comptroller Liu has assembled a team which is battling to create a speedier, more flexible and more rational investment process.

But it is uphill work. What is needed now is much bigger debate about how to manage the state pension funds, across the sector as a whole.

Sadly, though, this seems unlikely to happen; least of all before an election year.