Editorial: Some Dreamers of the Golden Dream

From aiCIO Magazine's Fall 2011 Issue: Editor-in-Chief Kip McDaniel on the public pension uproar.

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Joan Didion, in the 1966 article from which the title of this comment is plagiarized, wrote of a California outside the mainstream, of “not the coastal California of the subtropical twilights and the soft westerlies off the Pacific but a harsher California, haunted,” where “the future always looks good in the golden land, because no one remembers the past.” The drive from San Francisco to Sacramento to meet with CalSTRS’ CIO Chris Ailman reminded me of Didion’s desperate imagery—although what I encountered there was quite the opposite of a haunted land sans memory.

Ailman and his colleagues remember quite well, in fact, the criticism that public pension funds received this past year. Both politicians and, more surprisingly, asset managers have lambasted public pension benefits in some form or another. Blackstone chief strategist Byron Wien famously stated that taxpayers “literally can’t afford the benefits we have given our retirees in state and local governments and we have to change that” and, regardless of the claim’s veracity, Ailman and other CIOs resent such statements—especially in light of the stellar returns seen at public funds across the country. According to the Wilshire Trust Universe Comparison Service, the fiscal year ending June 30 saw American public plans outperformed both their corporate and endowment peers, bringing in an average 21% return. One year does not a model make, but such quantitative measures throw some amount of cold water on the heated rhetoric surrounding public sector benefits.

In truth, the problem was never the investment side of the equation. It can be argued that it wasn’t even on the benefits side of the equation. Instead, the problem lies with those willing to promise something and then complain about it. The early spring laments over government worker benefits foreshadowed, in hindsight, the July debate in Congress over the debt limit. Lost amidst Washington’s clamor was the fact that the politicians had already spent the money; the debate was over whether the President should be allowed to pay it. Regardless of political affiliation, the debate—when put in these terms—had a hint of the absurd.

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Politicians are one thing. Managers who want to work with public plans are another. Asset managers such as Blackstone have made their millions, billions even, managing public sector money. To reap the rewards of such relationships and then turn—unofficially even, as Wien’s comments surely were—against the source of such largesse shows a ludicrous lack of common sense. One New York-based asset manager told me the story of sitting across the table from a public fund and being read the riot act over comments made by one of the firm’s analysts. The manager was incredulous that a public fund representative would do this. I was incredulous that the manager didn’t understand that the hand that feeds him might be angered by such biting.

A 20% year will not quiet the critics—and, if public pensions are truly the albatross around America’s collective financial neck that leaders such as New Jersey Governor Chris Christie believe, it shouldn’t. However, facts are a stubborn thing: Benefits have been promised, and the teams established to manage those assets have proven that they are not the less-than-stellar-investors that some anonymous commentators make them out to be. The dreamers, then, are not Ailman and other CIOs such as Joe Dear. The dreamers are the ones who think they can promise benefits without paying them, who can criticize public employees and keep doing business with them.

—Kip McDaniel

Study: “Bigger Is Better When It Comes to Pension Plans”

In a recent Canadian academic paper, researchers assert that larger pension plans outperform their smaller peers due to asset allocation, internal management, and governance.

(September 9, 2011) – Larger pension plans such as Ontario Teachers’ and the New York State Common Retirement Fund are more likely than their smaller peers to provide better investment returns, recent academic work from University of Toronto researchers Alexander Dyck and Lukasz Pomorski shows. 

Unlike mutual funds, the authors argue in the paper, pension funds increase in performance as their size grows. “First and most strikingly, we find increasing returns to scale for pension plans,” the authors conclude. “Bigger is better when it comes to pension plans. Larger plans outperform smaller plans by 43-50 basis points per year in terms of their net abnormal returns. 

This is partially the result of a greater preference for internal management of assets at larger plans, the authors conclude. “While delivering similar gross returns, external active management is at least [three] times more expensive than internal active management, and in alternatives it is [five] times more expensive,” they write. 

Large plans also outperform because of asset allocation decisions unique to them, the authors write. “We find that larger plans shift towards asset classes where scale and negotiating power matter most and obtain superior performance in these asset classes,” they assert. “Larger plans devote significantly more assets to alternatives, where costs are high and where there is substantial variation in costs across plans.” Real estate and private equity add the most value, they insist. 

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Governance issues also influence returns, the study shows. “Finally, we present suggestive evidence that plan governance affects performance and the ability to fight scale diseconomies,” the authors write. “Long standing concerns about plan governance…are likely greater in the public than in the private sector, particularly where public plans have severe limits on pay for internal managers …We find that stronger governance provides higher returns and a greater ability to take advantage of scale economies.” 

The data on which the study is based comes from CEM Benchmarking, the well-known Canadian pension benchmarking company. 

For a look at the world’s largest asset owners – including the world’s largest defined benefit pension plans – go to aiCIO’s recently launched interactive database, the aiGlobal 500, here. 



To contact the <em>aiCIO</em> editor of this story: Kristopher McDaniel at <a href='mailto:kmcdaniel@assetinternational.com'>kmcdaniel@assetinternational.com</a>

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