Higher fees don't necessarily bring better returns for state pension plans.
In fact, high-fee plans posted some of the worst returns in 2012, according to a report from the Maryland Public Policy Institute and the Maryland Tax Education Foundation.
The report examined management fees for 46 states and compared investment results for 35 plans.
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The 10 states paying the highest fees — a median rate of 0.61 percent — posted annualized five-year returns of 1.34 percent.
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In comparison, the 10 lowest-paying states paid a median fee rate of only 0.22 percent and garnered 2.38 percent returns.
The study's median five-year return rate was 1.5 percent.
The states paying the highest fees (in order) were South Carolina, Mississippi, Pennsylvania, North Carolina and Maryland. (Hawaii, Nebraska, Rhode Island and West Virginia were not included among the data.)
In total, of the 46 pensions systems included, more than $9 billion in management fees were paid in 2012 alone.
The study suggests states would do well to move their more than $2 trillion in combined assets to indexed portfolios, resulting in a fee savings of $6 billion. The median five-year annualized return for indexed portfolios was 2.19 percent, higher than the actual median five-year return of 1.5 percent for the 46 pensions reviewed in the study.
Indeed, the notion of transitioning pensions to more passive index funds is gaining traction. The country's largest pension fund, the California Public Employees Retirement System floated the idea in March, amid dissatisfaction with active pension managers who continually lag behind the gains posted in index portfolios.
"There is simply no correlation between the high money management fees and high investment returns," said John J. Walters, co-author of the Maryland report.
For the five year-period of the study, 69 percent of domestic equity funds failed to outperform the S&P 500 benchmarks.
The study authors added that if states were to expand the small proportion of their pensions that are passively managed to 80 percent or 90 percent of their portfolios, "the annual savings, at a 7 percent liability discount rate, reduces unfunded pension liability by $80 billion," thereby improving results for both taxpayers and public sector employees.
The paper's authors also argued that state pension systems routinely fall for a Wall Street "sales pitch" that says fund professionals can outperform the market with their investment savvy. Yet they cite S&P Dow Jones data to show that over the five years ended Dec. 31, 69 percent of domestic equity funds failed to beat the S&P benchmark while fully 13 out of 14 bond benchmarks beat actively managed fixed-income funds.
They also decried what they view as a lack of accountability on the part of state pension system managers, who fall for the "sales pitch," add to costs by monitoring performance with the help of outside "Wall Street-type" investment consultants, yet take no action in response to underperformance.
The authors also reserved some choice words for Wall Street trends such as alternative investments, which they call "old wine in a new bottle," and private equity funds, whose portfolio valuations by independent CPAs they describe as "less than rigorous."
AdvisorOne's Gil Weinreich contributed to this report.
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