Recent news reports have spotlighted the high fees that state pension funds are forking over to investment managerspaid for by taxpayers. The real story is not the fees.
The story is what pols are getting for the fees. The risk is that theyre buying a fantasyone thats cheap now but will cost taxpayers megabucks later.
New York states pension fund is a good illustration. State Comptroller Tom DiNapoli manages this fund, worth $149.5 billion last year. He pays private managers to make sure that money turns into even more money tomorrow. That way, the state can guarantee benefits to 385,031 current retirees and their survivors and plan to make such payments to another 672,723 workers in the decades to comewithout asking taxpayers for more funds.
Last year, the state paid investment fees of $522.5 million to everyone from king-of-the-1-percenters Goldman Sachs to the tiny minority-owned Toussaint Capital Partners. Fees and commissions were up 54 percent from 5 years ago.
Yet taxpayers havent gotten what they were supposed to out of the deala bigger pension fund. The pension fund has grown only 5 percent since 2006less than half the rate of inflation.
The fees should have gone down, not up.
So why did they rise through the roof?
On Wall Street during the last 20 years, technology and competition have cut the profits of those banks and investment firms that didnt take risks themselves. Managing money for a state fund, rather than for shareholders, means not taking risks.
So to make higher profits without taking risk, Wall Street has learned to sell public-pension funds a luxury product: "alternative investments," such as hedge and private-equity funds, plus real estate.
Five years ago, the state pension fund spent $33.3 million on commissions to do the boring work of trading stocks and bonds1.9 percent of the amount traded. Last year, it paid $27.2 millionjust 1.2 percent. The fees that Wall Street managers get from managing plain old portfolios of stocks and bonds fell, too, by 23 percent as a percentage of assets over half a decade.
In an industry whose shareholders demand growth, thats a huge problem. Enter the "alternatives." The growth in New Yorks feesand how much Wall Street earnsup from $162.7 million a half a decade ago to $381 million, is because the state has increased its "alternativ" investments from $16.4 billion to $27.9 billion.
But why would the state pay more?
The promise of higher returns. The state has earned nearly 10 percent a year over a decade on private-equity investments, compared to 6 percent overall.
Higher returns mean that the state doesnt have to ask taxpayers for even more to fund any pension shortfalls. The problem is that these returns come with a huge risk: The gains can be illusory.
Consider: The state usually doesnt figure its returns by selling its assets. It figures out what its investments are worth by guessing.
Its easy to guess what, say, a share of ExxonMobilone of New Yorks biggest stock holdingsis worth. Because the market for those shares is so big, no one trader could manipulate or inflate the price.
But its not easy to figure out what the assets of a hedge fund are worth.
These firms can hold complex securities that trade on open markets rarely, if ever. The investments are worth what their owners say they are worthand everyone involved wants the values to go up.
Its not dishonesty (usually); its "cheerful" thinking. A Wall Street manager knows his bonus will be higher if the investments hes made rise in value. Life is easier for pols, too, if values of opaque investments go up, not down.
The risk for taxpayers is that while there may be alternative investments, there is no alternative reality.
When institutions and people are buying assets, their value goes up; when theyre selling them, their value drops. As the state workforce and the baby boomers retire, values face downward pressure. As DiNapoli notes, "The number of retirees is increasing more quickly than members."
Federal bailouts over the last five years so far have staved off this reality but cant do so forever.
Unless taxpayers demand more public-pension reform, they may find themselves paying more for public-sector pensions later.
Original Source: http://www.nypost.com/p/news/opinion/opedcolumnists/ny_risky_luxury_investments_sgNGMCTre1zb5ixlvi1sbM