Pennsylvania pension fund begins transition to lower-cost investment strategy
Pennsylvania’s $72 billion pension fund for public school employees has taken a major step toward lowering investment management fees. On December 18, the board of directors of the Public School Employees Retirement System (PSERS) approved an update to its investment policies that includes a plan to eliminate $6 billion in hedge funds and reallocate the product to lower cost investments over time.
Implemented as an update to the plan’s target asset allocation, the change will affect approximately 8% of the system’s portfolio and could reduce annual investment costs by more than $100 million. Reducing these fees keeps more money in the pension system to fund pension benefits instead of covering external management costs.
The investment fees and transparency practices of Pennsylvania’s two major public employee retirement systems have attracted attention in the state for several years. In 2017, lawmakers established the Public Pensions and Asset Investment Management Review Commission as part of the comprehensive Bill 5 pension reform legislation, in part to review these practices for the PSERS and the Pennsylvania State Employees Retirement System (SERS).
More recently, FBI and federal prosecutors, as well as the Securities and Exchange Commission, began investigating PSERS financial records to determine whether plan officials exaggerated investment fund earnings and accepted gifts or rewards. money from outside advisers and investment consultants. The PSERS said it is fully committed to cooperating with both investigations, which are ongoing. On November 18, the PSERS board announced that the scheme’s executive director and chief investment officer would retire in the first half of 2022.
With the board’s approval of the new strategy, which also has the effect of slightly increasing the system’s risk profile, administrators are now expected to implement the changes over the coming months and years. The vote represents the most concrete action yet to implement the fee savings recommendations made in 2018 by the Act 5 Investment Committee. Lawmakers asked this panel to identify 3 billion dollars in potential savings on investment costs in the two 30-year plans and to suggest improvements to transparency and risk reporting practices.
Research showing that investing fees in Pennsylvania were among the highest in the nation helped inform the savings goal and broader commission mandate. In the most recent PSERS financial report, for example, the scheme reported a total of $584 million in investment fees, an amount that exceeds 0.8% of assets, more than double the national average.
The expert panel met throughout 2018 and released a final report in December of that year identifying nearly $10 billion in potential fee savings – far exceeding the legislative mandate – and making recommendations for strengthening investment transparency practices and conducting annual stress tests that assess plan performance within a range of economic conditions. Researchers from The Pew Charitable Trusts provided technical assistance on stress testing during the commission process and on creating the commission as part of Act 5. The most recent effort could save $3 billions of dollars ; additional fee reduction initiatives are underway at SERS and PSERS.
The decision to significantly change the investment strategy was initiated at the October meeting of the PSERS Board of Directors by Richard Vague, Pennsylvania Banking and Securities Secretary. Former state treasurer Joe Torsella, vice chairman of the 2018 Investments Committee, also backed the strategy. The plan’s investment staff then proposed the specific asset allocation changes for board approval at the December meeting.
The board has focused its fee reduction effort on the absolute return asset class, which includes investments in several hedge fund strategies designed to diversify the overall portfolio by generating positive returns with low volatility and low correlation with equities and government bonds. These investments made up less than 10% of the portfolio, but generated nearly a third of all fees paid in 2021, according to asset class-level fee data that was published in the PSERS annual reports. since 2015.
Pew’s top investment transparency recommendations focus in part on disclosing this information to inform investment strategies. The PSERS Investment Committee and Board of Directors have reviewed and analyzed additional information on fee structures for other asset classes, including private equity performance fees. Incorporating these fees into the plan’s regular reports is an additional step that would provide a more complete picture of the fees paid and bring the system’s procedures more in line with Pew’s recommendations.
An update on the implementation of Pew’s recommendations and a discussion of transparency issues facing state pension systems will be included in an upcoming brief. For this research, analysts examined transparency practices in all 50 states, compiling data on the asset allocation, performance and fees of the 73 largest state-sponsored pension funds, including those of Pennsylvania.
Greg Mennis is the Director and Lennox Kohn is an Associate of The Pew Charitable Trusts Public Sector Retirement Systems Project.