How Pension Funds Destroy Investors’ Wealth

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As the following research shows, state and local pension funds invest more than $2 trillion on behalf of beneficiaries. The stock market crash of 2008, the steep decline in interest rates, and the growing problem of unfunded pension liabilities led many pension plans to attempt to outperform public stock and bond benchmarks.

Jeff Hooke and Ken Yook, authors of the study “The Grand Experiment: The State and Municipal Pension Fund Diversification into Alternative Assets,” published in the Fall 2018 issue of the Journal of Investing, found that over the 20-year period 1996 to 2016, pension plan allocations to hedge funds increased from 0% to 6%, and their allocations to private equity increased from just 3% to 11%. The authors also noted that these increases mostly came at the expense of allocations to fixed income, which fell from 43% to 26%.

While investments in passively managed public equity and public debt funds (such as index funds) come with low expense ratios, investments in private equity and hedge funds come with much higher expenses – with fees typically in the range of 1.5-2.0% plus a performance fee (typically 20%).

Hooke and Yook noted that these fees now exceed $15 billion a year. They studied the performance of state pension plans from 1997 through 2016 to determine if the fees were justified by superior performance.