How Maryland’s pension became a billion-dollar business for Wall Street – Baltimore Sun

The public pension system used to invest almost all of its money in stocks and bonds. Then came the Great Recession in late 2007. Stocks fell off a cliff, bond yields plummeted, and public pension funds across the country lost hundreds of billions of dollars.

For the first time, many pension plans are beginning to look beyond the stocks and bonds that are the bread and butter of most retirement accounts, making high-cost, actively managed “alternative investments” part of their portfolios. These investments, such as private equity, promised attractive returns.

A few years before the recession, Maryland’s retirement plan stepped into a private equity fund that bought, retooled, and sold companies. As pressure was put on then-struggling pension funds, the system plummeted, pouring more and more money into private equity and other high-cost investments.

The pension system is now at its healthiest level of funding in a decade and has grown in most years since the Great Recession. The system’s assets have more than doubled from his $27 billion 20 years ago to his $64 billion today. But what is being paid to Wall Street to manage these investments is growing much more rapidly. The system currently pays money managers about $1 billion annually in fees and incentives. That’s 25 times his $40 million for her 20 years ago.

The fund’s chief investment officer, Andrew Palmer, said looking at fees and incentives is like looking at a landscape through a straw. The big picture is that the fund’s investments, including those with high costs, are profitable, he said.

“We look at returns net of fees. We want to make sure we aren’t paying fees on just market returns that don’t serve us,” Palmer said. I’m here. “We are aware of the charges.”

Many of these fees and incentives come from private equity investments. Generally speaking, private equity firms buy companies, make aggressive changes, and then sell them, hopefully making a profit. These companies typically promise higher returns than traditional investments.

Prior to 2005, the Maryland Pension Plan had never invested in private equity. In 2007, on the brink of a financial crisis, the pension plan aimed to invest 2% of his portfolio in private equity. Over the next two years, the pension plan lost about $9 billion in value, and pension managers rushed to pivot to private equity, raising its target allocation to his 15%. As of last year, more than 21% of the value of annuities was private equity.

The move to private equity mirrors that of other public pension funds across the country.

When the Great Recession devastated pension investment portfolios across the country, pressure to scale up or suffer shortages of funds increased as more teachers, firefighters, police, and other civil servants retired. The number of retirees and beneficiaries drawing money from Maryland’s pension plan has nearly doubled over the past 20 years to 172,000, while the number of active employees is 194,000. remains almost the same.

In response, states pumped more money into pension plans, cut benefits, and required employees to tip more out of their paychecks. Meanwhile, many pension fund managers put a lot of money into private equity and other “alternative investments.” These investments typically require aggressive management and high fees.

In Maryland, these decisions appear to be working. The soundness of the pension system is generally measured by the “funding ratio.” A funding ratio of 100% means that the pension plan has sufficient funds to cover the pension benefits of current and future members. Few public pension plans are 100% funded, but in Maryland he was over 90% in the early 2000s.

According to financial reports, Maryland’s pension plan funding rate has steadily increased from a low point of 64% in 2010 to 77% last year.

Part of that success is due to private equity investments, according to Palmer.

“In these markets, you get what you pay for,” says Palmer. “Long history [of private equity] It has been productive and we expect it to remain productive relative to the public market over the next decade. “

While that may be the case with Maryland’s pension plan, there is a broader national debate about how pension funds should approach private equity and whether it’s worth the fees Wall Street charges. A discussion is taking place.

“The answers to these questions are less clear,” said Gang Cheng, co-director of state and local government finance projects at the University of Albany. “it’s complicated.”

The advantage of private equity is that it can diversify the pension portfolio and boost the fund’s expected annual return, Chen said. Even small percentage changes in these returns can have a significant impact on pension fund growth.

On the other hand, Chen said the value of private equity investments is not transparent. Anyone can search Ford Motor Co. on their smartphone and instantly see the automaker’s share price, but that’s not how Private His Equity works.

Without public data, it is difficult to draw firm conclusions about pension fund performance and the fees they pay to manage their investments, Chen said. One of the places he looks for data is Boston College’s Retirement Research Center, which collects and publishes information about pension plans.

Jean-Pierre Aubry, Associate Director of the Center, said: published a paper Have alternative investments—private equity, hedge funds, real estate, etc.—helped or hurt the public pension system over the past two decades?

Aubrey said it’s basically a wash compared to the stock market, but the pension plan has had to try something different to meet the aggressive returns that many states want.

Still, some economists, like Eileen Appelbaum, have deeper concerns about private equity. Applebaum is co-director of the Center for Economic Policy Research in Washington, DC.

Wall Street managers have financial incentives to exaggerate their successes, she said. Appelbaum believes many private his equity his funds overvalue the companies in their portfolios, and if a recession hits, these funds will be caught with pants around their ankles.

“If you’re a pension fund manager… what’s the motivation for calling their bluff?” Apelbaum said. “Being cynic is bad for your career in the pension fund world. Even asking questions is bad for your career.”

Not all public pension plans employ such a costly and active investment strategy.Nevada Retirement System famous for passivity.

Maryland’s pension system is slightly larger than Nevada’s, but pays eight times as much in fees. Despite paying Wall Street investment managers much less, Nevada’s pension plan has earned higher returns than Maryland’s for nine of the last decade.

For Jeff Hooke, one of Maryland’s toughest critics of the pension system, nothing could be clearer. Hook is a lecturer at the Johns Hopkins Carey Business School and a former investment banker involved in private equity transactions.

Hooke was always skeptical of private equity, but he said his skepticism has since turned into a “full-time hobby” that includes writing a book on the subject. Summarized. Consistently beating stock market returns is extremely difficult, especially when investment managers charge fees.

“I use my knowledge on a pro bono basis to advertise,” Hook said. “All I get is rotten tomatoes thrown at me by the industry.”

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Hook made some progress. He testified before state legislators, and in 2019 the legislature passed a law making Maryland one of his few states with a pension system. Must disclose incentives paid to external investment managers.

In 2021, these Wall Street investment managers made more than $370 million from Maryland’s pension plan through profit-sharing arrangements like this one. While the pension scheme provides most of the profits, managers also receive cuts to incentivize performance.

During this legislative session, Baltimore County Republican Rep. Robin Grammer said: submitted another bill Defended by Hook. The bill would have forced Maryland’s pension system to blow up its current investment strategy and adopt a low-cost strategy like Nevada’s. The bill did not pass, and Grammer did not respond to a request for comment.

Palmer is happy that the bill has passed. He knows Nevada makes a lot of money these days, but it’s not just about revenue, he said. It is also important to control volatility, reduce risk and diversify the portfolio.

If profitability is everything, look at Washington state, Palmer said. Washington’s pension plan outperformed the Maryland pension plan, as private he invested more aggressively in equity and other high-cost investments.

According to Palmer, the problem isn’t that Nevada or Washington have the best investment strategies. The bottom line is that Maryland has strategies that align with the Pension Board’s and beneficiary’s risk tolerance, diversification goals, and investment goals.

“One of the things I’ve discovered in this business is that there are countless ways to do this and be successful,” says Palmer. “What really matters is finding a way that works for the organization you’re involved with.”