(Bloomberg) -- To ease Pennsylvania’s pension obligation, GovernorTom Wolf isn’t targeting public workers, the focus in neighboringNew Jersey and around the country. He’s eyeing payments to WallStreet.

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The first-term Democrat is calling for Pennsylvania’s twopension systems to reduce investment-manager fees that are higherthan the average U.S. public plan. He’s also counting on WallStreet banks to market bonds the state would use to bolster one ofthe funds.

Also read: How3 public pensions got their houses in order

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As retirement costs consume a growing share ofmunicipal budgets, pension boards are scrutinizing payments tomoney managers. California PublicEmployees’ Retirement System plans to liquidate itshedge-fund program, while Pennsylvania’s Montgomery County movedmost of its holdings to cheaper, passively managed funds, whichtrack indexes. Wolf wants to adopt lower-cost approaches that maysave $200 million annually.

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“We’re not talking about suddenly overnight going to a 100percent passive investment strategy,” said Randy Albright, Wolf’sbudget secretary. “We’re talking about strategically re- evaluatingthe mix and trying to look at ways that they can reduce risk andreduce fees.”

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Taxpayer Dollars

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Pennsylvania ranked second-to-last after New Jersey among statesby the percentage of the required pension contribution that it madefrom 2001 to 2013, according to a March report from the NationalAssociation of State Retirement Administrators. Ratingscompanies cite the pension burden in giving Pennsylvania a gradetwo steps below the average for U.S. states. Standard & Poor’sand Fitch Ratings cut their marks in September to AA-,fourth-highest. Moody’s Investors Service lowered it to anequivalent Aa3 in July.

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In his first budget address this month, Wolf said Pennsylvania“has been wasting hundreds of millions of taxpayer dollars on WallStreet managers.”

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Across the country, pension funds are examining theirrelationships with investment firms, said Greg Mennis, director ofthe states’ public-sector retirement systems project atthe Pew Charitable Trusts. They’re reconsidering their strategiesafter expanding higher-cost alternative investments, such as hedgefunds, he said.

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County Shift

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California’s retirement system, the biggest statepension fund, said this month it expects to pay 8 percent less formoney managers as it drops hedge funds. In Montgomery Countynorthwest of Philadelphia, shifting most assets to ValleyForge-based Vanguard Group Inc. cut expenses by more thantwo-thirds, Josh Shapiro, county board of commissioners chairman,wrote in the Philadelphia Inquirer this month.

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Pennsylvania administers two plans coveringabout 700,000 people. The funds had 62 percent of assets needed tocover promised benefits in 2013, down from 75 percent in 2010, fora combined unfunded liability of about $53 billion.

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The largest system, the Public SchoolEmployees’ Retirement System, paid 1.14 percent of assetsin fees in 2013, compared with the 0.42 percent average for U.S.public plans, according to the Center forRetirement Researchat Boston College. The Pennsylvania StateEmployees’ Retirement System also exceeded the average,paying 0.66 percent.

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Officials are asking the retirement boards to lowerfees to about 0.6 percent, said Albright, the budget secretary.

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The call to reduce payments represents a “distraction” and a“sideshow” that won’t reverse years of underfunding and the costsof a system that guarantees worker payments, said Paul Mansour,head of municipal research at Conning.

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“You really need to attack the benefit levels either forexisting employees, or certainly for new ones,” said Mansour, whoseHartford, Connecticut-based company oversees $11 billion in munis.“Otherwise, it’s going to be a continued problem.”

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Public pension officials can’t just look at savings -- they havea responsibility to do what’s best for their funds andbeneficiaries, said Keith Brainard, research director for thestate retirement administrators’ group.

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“You’re not investing the money to save money,” he said fromGeorgetown, Texas. “You’re investing the money in order to generateinvestment earnings within an acceptable level of risk.”

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Liability Focus

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Albright said he’s confident the funds would achieve the samereturn target. Yet Evelyn Williams, a spokeswoman for the schoolworkers’ pension, said a strategy involving lower fees wouldprobably produce a lower assumed rate of return.

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“The unfunded liability is too large for any significant impact,even if there were no management fees at all,” she said in ane-mail.

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Williams and Pamela Hile, a spokeswoman for the state workers’system, said the management fees resulted from investmentstrategies that propelled their funds to earnings above indexeswhile meeting risk standards.

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Over the past 15 years, the school workers’fund paid managers $4.96 billion and generated a net $11.5 billionin returns above indexes, Williams said. The fund for stateemployees earned $19.7 billion net of fees while paying $2.4billion in fees in the past decade, Hile said.

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Savings Quest

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The state workers’ system “constantly looks for cost savings andaggressively negotiates fees, and that focus has reduced totalinvestment costs by $70 million over the past five years,” Hilesaid in an e-mail.

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Wolf, a 66-year-old former businessman, also wants to sell $3billion of pension bonds and direct the proceeds into the schoolworkers’ fund, which has the greater unfunded liability at $35billion. The move would pay off if the pension’s investmentearnings are greater than the borrowing costs on the debt,underscoring the significance of any changes in the system’s assetmanagers.

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Pennsylvania’s projected contributions to the systems rise to acombined $6 billion annually in 2035, from about $3 billion nextfiscal year.

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Unlike Illinois, which is fighting a court battle to cut workerbenefits, and New Jersey, where Governor Chris Christie wantsteachers to freeze current pension benefits, in Pennsylvania, Wolfisn’t seeking givebacks from employees.

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Pennsylvania’s task is to make up for years of underfundingrather than trim benefits, Albright said. Legislation enacted in2010 already raised retirement ages and cut costs, hesaid.

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“We already have restructured our current employee benefit planto a relatively inexpensive one,” he said.

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