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Public pension funds management makes the grade claims CalPERS Back  
The experience of the United States provides some salient points for Ireland’s beginning debate over separately funded public pension funds, including strong assertions that private sector pension managers don’t outperform public sector managers and political interference in pension funds can be rebuffed.
A controversial public debate has taken place in the US over a suggestion by President
Clinton that social security funds may be invested in the stock market. This debate has raised some of the same issues involved in Finance Minister Charlie McCreevy’s plan to set aside ?1 billion in Telecom proceeds and 1% of GNP for a public, segregated pension fund.

This plan is close to, while not exactly the same as, CalPERS, the California Public Employees’ Retirement System, which manages a defined benefit scheme for more than 1.1 million California public employees, retirees, and their families. Although it is not a social security pension system for the entire population of California, its 1.1 beneficiaries, including 332,000 retirees, compares with 449,000 state pension recipients in Ireland.

CalPERS manages assets of $154 billion, and is the largest pension fund of its kind in the US. 11 per cent of its assets are invested in Californian bonds, equities and real estate. It employs its own investment managers, but also contracts in consultants and allocates a certain proportion of assets to index-tracking investments. Its average annual return was 13.2 percent over the last ten years. According to CalPERS, a total of 86 per cent of the fund’s growth came from investment performance. Its current asset allocation is shown in the table.

Public vs private management

Earlier this year, CalPERS CEO, James Burton, released two studies which, he said, ‘debunk the myth that public pension funds underperform corporate pension funds’.

He said, ‘The tremendous success of public pension funds is being ignored in the debate over investing social security funds in the U.S. stock market, and the arguments that public funds can’t invest in the exclusive best interests of beneficiaries are based on outdated data and the myth that the public sector ‘can do nothing right’.’

‘The statements by some politicians that public pension funds fare worse than private funds and that they are controlled by the whims of party politics are inaccurate and misleading.

Burton based his argument on four points

l ‘The U.S. equity investment return of large public pension funds have matched or exceeded that of private pension funds for the last 10 years;

l Public pension funds achieve their comparable performance at notably less risk to their beneficiaries than is the case with private pension funds;

l There is no compelling evidence of widespread political meddling. Most pension systems are left alone to make their own decisions about investments;

l Most public pension funds operate with independent fiduciaries using the ‘prudent person’ or ‘prudent expert’ standard. Legal and ethical walls exist which can prevent political control.’

Study results

Two studies were used to support Burton’s arguments. California-based Wilshire Associates looked at the 10-year performance of 50 large corporate and 50 large public pension funds with combined assets totaling $870 billion.

According to CalPERS, Wilshire’s review found that the annualized median U.S. equity return of the 10-year period ended September 30, 1998 was 15.6 percent for public pension funds compared to 15.4 percent for corporate pension funds. They found there were no systematic differences in the investment performance of U.S. stock portfolios managed by public or private pension funds. There was less than a one per cent difference in median total funds performance in favour of corporate pension funds, due entirely to corporate funds portfolios having greater equity allocations, not the result of better management of the assets.

A second analysis quoted by CalPERS was conducted by Toronto-based Cost Effectiveness Measurement, Inc. (CEM), a global provider of standardized benchmarking information on the organizational performance of pension funds. CEM looked at continuous four-year data histories of 51 U.S. corporate and 34 U.S. public pension funds.

CEM found that the average cost effectiveness performance of public funds was better over the 1994-1997 period than that of corporate funds. On average, the public and corporate funds both produced the same total gross returns relative to their own policy benchmarks, but public funds did so with somewhat lower operating costs and lower risk exposure than the corporate funds.
CEM’s report stated that fund size, the proportion of assets passively managed, and the quality of the fund’s organization design drives performance. ‘Large size and high degrees of passive management are positively associated with positive risk adjusted, net pension fund returns, as is good governance and good organisation structure. Once these fund attributes are accounted for, the type of pension fund sponsorship offers no additional statistical power in explaining pension fund performance.’

Three drivers of pension performance

CEM said their study suggested that:

l ‘Bigger is better in pension fund management for two reasons. First, with increased size come increased economies of scale and lower unit operating costs. Perhaps more importantly, with increased size comes the ability to support a full-time professional management team dedicated to producing positive risk adjusted net value added.

l The positive relationship between risk-adjusted net value added and the proportion of the fund passively managed probably arises because high fund proportions subjected to passive management are good proxies for high levels of understanding by a fund’s governing and managing fiduciaries that (1) financial markets are generally informationally efficient and that, (2) therefore, active management can be successfully applied only at the margin, rather than to the entire fund.

l Organisation design theory strongly suggests that organisations which (a) are clear about their mission, (b) have a strong governance function, (c) have optimal layering and clear delegation within the organisation, and (d) align compensation with the achievement of organization goals should achieve superior organisation performance.’

CEM’s argument is that these features could be put in place in either a public or private pension fund.

Political Interference

Burton acknowledged that public pension fund performance generally lagged behind corporate fund performance twenty years ago, largely due to limits then placed by state legislatures on how much public pension systems can invest in certain type of investments.

He went on, ‘Do public pension systems receive pressure from politicians from time to time? Yes, they do. But at CalPERS, we have an excellent track record of rebuffing political interference. Just ask the politicians in California who tried to raid our fund by delaying payments. The California Court of Appeals required the state to pay us back to the tune of $1.2 billion, and added $330 million in interest as a penalty. That reflects the vigilance that is possible by independent fiduciaries - including the elected officials on our own board.

‘It may be politically opportunistic to denigrate public pensions as a way to make the case against Social Security stock investment. But it simply doesn’t hold up against the performance record. At CalPERS, we have managed to remain independent and perform very well. The decision as to whether Social Security funds should be invested in the market presents major challenges. It should be made not on the basis of outdated information about public pension funds, but rather on a thorough and rational analysis of all the facts.’

In 1998, CalPERS banned political contributions to CalPERS fiduciaries and required fiduciaries to publicly report all gifts received. It also required parties who do, or seek to do, business with the retirement system to disclose all gifts, including political contributions, to CalPERS board members, candidates for the board, and senior staff.

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