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Understanding the Monster of Pension Fund Management
Arthur Frankenstein’s creation is a cautionary tale of how well-intentioned ideas can lead to disastrous outcomes. The same sentiment holds true for pension funds across the United States, which were designed to secure comfortable retirements for public workers. However, with over 150 asset managers on average engaged per large pension fund, the complexities that arise from this diversification strategy may in many instances amount to inefficiency rather than the desired security.
The Price of Excessive Diversification
In a quest to comply with fiduciary obligations to diversify, many public pension plans allocate substantial portions of their assets to alternative investments. This practice incurs significant expenses, averaging between 100 to 150 basis points annually. The fallout? Many pension funds are underperforming broad market indices by similar margins, which means the taxpayers, who ultimately fund these plans, are bearing the brunt of these inefficiencies.
Unintentional Consolidation of Investment Strategies
When multiple pension funds coexist within the same jurisdiction, an unintended consequence emerges. Taxpayers are affected by overlapping investments that essentially neutralize each other's performance. In metropolitan areas, like Los Angeles, this overlap can include multiple city and state pension funds, each with their own investment strategies but together creating a muddled investment landscape.
Time for Structural Change
To address these inefficiencies, some suggest a revision in the management structure of pension funds. For example, states like Minnesota have implemented state boards of investment to pool resources from various pension plans, promoting collective efficiency. While this approach shows promise, it also underscores the necessity for warding off the inefficiencies exhibited when assets are managed in isolation.
The Path Forward
Ultimately, the future of public pension funds hinges on recognizing the intrinsic dangers of excessive complexity and a re-commitment to streamlined, efficient diversification strategies. Stakeholders must rethink the way they manage these funds, considering whether the existing paradigm is truly serving the interests of retirees and taxpayers alike.
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