First in a three-part series
But 5.2% looks pretty grand when you compare it with the state’s second-largest public pension plan. The Employees Retirement System of Texas pension clocked in with a dismal 3%.
That superiority wasn’t a one-shot deal, either. The TRS pension fund also beat the ERS pension returns over the trailing three- and 10-year periods.
How about the other state and local pension plans in Texas? Sorry, that’s hard to tell. While the pension database on the Comptroller of Texas website lists all 99 plans and their trailing returns, plan reporting dates differ. So true apples-to-apples return comparisons for the same time periods aren’t possible from available data.
But measured against the other plans whose fiscal years close Aug. 31, the TRS tromps the competition in all three time periods.
So Texas teachers should be happy and proud, right?
Maybe. Maybe not.
Let’s put it in a broader context.
Here’s the situation. The TRS pension fund puts an army of investment managers to work with the single-minded goal of achieving its targeted 7.25% return. Do that, and teachers will have the retirement income they’ve been promised.
So the fund has investments in lots of asset classes. It also has investments in alternative assets, such as hedge funds of all kinds, private equity and natural resources.
To put it in precise, technical terms: It has investment products and talent out the wazoo.
But variety and talent don’t come cheap. Indeed, according to the Comprehensive Annual Report, compensation and incentives for fund managers clocked in at a cool $1.3 billion for the year. That’s about 0.83% of fund assets, a rather high amount for a fund with $157.4 billion in assets. The fund spent an additional $62.5 million on brokerage commissions.
You can find out why the TRS pension costs are so high on Page 111 of the report. More than 90% of the management fees go to those “alternative investments.” These are intensely managed investments best known for their high fees. In addition to a high basic fee, they take a hefty percentage of the profits. Warren Buffett has described such fees as “obscene.”
Yet, in spite of those lurid expenses, the TRS fund has put nearly half of its assets, $72.2 billion, in such funds. It also has committed an additional $36.9 billion to such investments in future years, a fact you’ll find on Page 56 of the report.
TRS is far from alone. Pension funds and endowments across the country have been investing in hedge funds/alternative assets for years. One reason is that many managers believe regular assets, like stocks and bonds, won’t produce the returns they need. If TRS is making a mistake, it will have lots of company.
In the context of conventional thinking in the investment world, expensive hedge funds are the way to go. There are two major reasons for this.
The first reason is that it supports a belief that investment skills and smarts can bring good results. If the managers didn’t believe that, they would need to find another profession. It would probably pay far less.
More than half a century of studies and evidence, however, has found that good performance is, well, a random event.
The second reason will concern teachers and taxpayers. Believing in high returns from alternative investments eliminates the politically horrifying need to tell the Texas Legislature that the 7.25% return goal won’t be met.
The only alternative? Increase the cash contributions from teachers, school systems and the Legislature.
Messengers have been shot for less.
But let’s get back to context.
Investment managers love being measured against other investment managers. That makes it like a game of musical chairs. The folks with the worst returns lose their jobs, but everyone else remains happily employed.
Things look quite different when you change the measuring stick. The one I have used for decades is low-cost index investing.
It’s easy to do. We simply compare TRS fund returns to the performance of the Vanguard Balanced Index fund. And since we’re going to invest more than $10,000, we can put that $157.4 billion into the still lower-cost Admiral shares of the fund.
That will cost 0.07% a year.
As you can see from the accompanying table, Vanguard Balanced Index Admiral shares provided a higher return than the TRS pension fund — for all of its intense management — over the last year, three-year, five-year and 10-year periods. I also compared the returns in each individual year of the last 10 and found that Vanguard Balanced Index Admiral shares provided a higher return in six of the 10.
The superiority of low-cost index investing suggests that a lot of money for teacher retirements is being siphoned off into the pockets of well-meaning and very well-paid investment managers.
So let’s ask a trustee-like question. What if that money went to teachers? What would it do?
We can get an inkling by answering a simple question. How many years of average teacher pension income could all that management expense buy?
Here’s the math.
The average teacher monthly life annuity payment in 2019 was $2,096. That’s $25,152 a year. Divide that number into the $1,305,067,683 spent on investment management, and you get 51,887 additional years of teacher retirement income.
Yes, you read that right: 51,887 years of pension income.
My bet is the investment manager trustees at TRS have never thought about it this way. Maybe some other people in Austin should.
Next week: Scott Burns takes a look at the other 98 state and local pension plans in Texas.
Scott Burns is the creator of Couch Potato investing and a longtime personal finance columnist for The Dallas Morning News.
Twitter: @scottburnsSAL