Investment Strategy Explained in Response to Recent Report on State Pension System

A statement from the State Retirement Agency’s Chief Investment Officer responds to the most recent critical report of the Maryland Public Policy Institute.

About half of Maryland’s counties participate in the State Pension System for pension coverage for their employees. Those counties pay employer contribution to the System. All counties provide funding for teacher pensions, also a part of the State Pension System, through contributions to local Boards of Education. Maryland counties and municipalities have two seats on the State Pension Board of Trustees.

The Maryland Public Policy Institute has regularly offered criticism of the State Pension System’s investment strategies, and specifically, to the fees paid to active investment managers on Wall Street.

The recent report by the Institute points to fees paid by the State Pension System to investment advisors might be better spent on reducing the System’s unfunded liability, stating,

In 2017, the total estimated fees for Maryland was $506 million. For all 33 states, the total fee load was $9.83 billion, despite the median state underperforming a passive
composite index. Capitalizing the fee load at 5 percent suggests a reduction in unfunded liability of $200 billion, assuming the indexes continue to outperform the states’ complex constructed portfolios.

In a statement in response to this report, entitled, “Think Tank’s” recent work of fiction, the State Retirement Agency’s Chief Investment Officer provides a pointed critique of that report, and offers information to explain the basis for the System’s investment strategy and past practices.

CIO Andrew Palmer states that the figures used in the MPPI report are inaccurate,

MPPI claims that the System paid $505.6 million in management fees in the fiscal year ending June 30, 2017, which includes an assumption for performance-based compensation (known as carried interest) earned by the System’s asset managers. This is an assumption not based on actual historical experience or quantitative modeling, but rather, it was simply made-up. This fabricated number overstates the amount of the System’s most recent performance-based fee calculation by an astonishing $84.6 million, or nearly 97%. Errors of this magnitude have a profound impact on the results of the report, rendering it completely unreliable.

Later in the report, Palmer shares how the Pension System’s careful mix of active and passive investment strategies has paid off, stating,

The System pays careful attention to ensure that it is compensated for the higher fees it pays to active managers. In efficient asset classes where the likelihood of successful active management is low, the System employs a predominantly passive strategy. As of March 31, 2018, the passive investments represented 18.3% of the total fund, or roughly $9.5 billion. In inefficient asset classes and asset classes that cannot be managed passively, active strategies are utilized. Table 2 below shows that the System has added value, net of all fees and expenses, over a fully passive alternative to its asset allocation. While not shown, the System achieved these superior returns while experiencing lower return volatility than the Passive Benchmark.

Screenshot 2018-05-17 11.45.05
From “Think Tank’s” recent work of fiction, by Andrew Palmer, CIO

For more information, read the letter from State Pension Chief Investment Officer Andrew Palmer.

For background, see the 2018 State Pension Fund Investment Performance Report from the Maryland Public Policy Institute.