Over the last decade, fund managers who oversee the pensions of the nation’s teachers, firefighters, police and other government workers have doubled down on an investment strategy that has cost U.S. taxpayers at least $600 billion, possibly more than $1 trillion, investment data and calculations by Yahoo Finance found.
Seeking higher gains, pension fund managers have upped their investment in so-called alternative strategies that are costly and weigh down returns, data shows.
“We find that some of the worst-performing plans are those that went into alternatives late in the last decade,” said Jean-Pierre Aubry, a research director at the Center for Retirement Research at Boston College who studied the impact of investing in alternatives on public pension funds.
Alternative funds invest in things like hedge funds, private equity, real estate or commodities, rather than traditional stocks and bonds. Because pensions are guaranteed, the underperformance has hit taxpayers in the form of budget cuts for schools, hospitals and libraries and decreased spending on infrastructure, health care and other public projects.
Aubry’s studies show that across the board, public pension fund managers have thrown increasingly more money at these complex and pricey alternative funds, despite the fact that they consistently underperform simple index funds available for a fraction of the fee cost.
Fund managers have moved to alternative investments, in part, because when competing for the contracts to manage pensions, they sold pension boards on expected high returns that have not materialized. They are now trying to provide a jolt to the plans, which are largely underfunded, said Scott Kubie, chief investment officer at financial management firm Carson Group.
“Those high assumptions allowed to make not as high contributions,” Kubie told Yahoo Finance. “They’re trying to find a way to catch up… because they haven’t covered the liabilities. I don’t know if that ends particularly well.”
Several studies have shown that pension fund managers are unable to consistently beat the market. And the growing popularity of alternative investments has only exacerbated the trend.
Data from the Center for Retirement Research at Boston College shows that state and local pension plans steadily increased their holdings of alternative investments, rising from 9% in 2005 to 24% in 2015. A 2017 study from Coller Capital found that a net 23% of investors plan to increase their allocations to private equity over the next 12 months.
With the nation’s pension liabilities having risen to $6 trillion, Jeff Hooke, a lecturer at Johns Hopkins University, recently conducted a report for the Maryland Public Policy Institute that found the state had lost billions in retiree income on account of the fees and lost revenue.
“The sales pitch of the alternatives community is ‘We’ve got some kind of secret sauce. Our returns are going to be higher than stocks and bonds,’” Hooke, who has authored numerous studies on the performance of public pension funds, told Yahoo Finance. “The only problem with the sales pitch is it doesn’t work.”
Alternative investments are speculative in nature, and may not be suitable for all investors. The strategies employed in the management of such investments involve increased risks, including the potential loss of part of the entire principal amount invested. To determine which investment may be appropriate for you, consult with your financial, tax or legal professional. Please remember that investment decisions should be based on an individual’s goals, time horizon and risk tolerance. The opinion expressed in this article do not reflect those of Cetera Financial Group.