For state pension funds with Wall Street managers, 'more fees equal lower returns'

A good number of state pension funds, which provide retirement income for state government employees, have their money managed by Wall Street firms including hedge funds.

According to one study, the more the manager takes in fees, the worse the fund is doing.

Jeff Hooke and John Walters of the Maryland Public Policy Institute, which has been described as a conservative-leaning group, tracked the returns of 33 state pension funds and found that those that paid higher fees recognized lower returns than those with low fees.

"The top 10 states in terms of Wall Street fees had lower pension fund investment performance over the last five fiscal years than the bottom 10 states," wrote Hooke and Walters.

The 10 states paying the highest fees paid an average fee of 0.66% of invested capital over the last 5 years, while the 10 lowest paid 0.26%. During that time, the top fee payers had an average annualized return of 12.44%, while the lowest fee payers had a return of 12.70%.

So for 0.4% more in fees, the highest payers got back 0.26% less per year.

"For the five years ending June 30, 2014, we were unable to find a positive correlation between high fees and high returns. In fact, we found a negative correlation," said Hooke and Walters.

The study followed up on initial research from 2012, but Hooke and Walters said the findings were the same. "The Maryland Public Policy Institute updates calculations completed two years ago for the fiscal year ending June 30, 2012. The conclusions then are identical to those today-more fees equal lower returns," they wrote.

Hooke and Walters found that stock-picking active mangers are just doing a poor job of handling the state's money.

"Evidence suggests that managers who select publicly-traded securities (on behalf of clients) cannot beat benchmark indices," said Hooke and Walters. "According to the S&P Dow Jones Indices/SPIVA Scorecard Year-Ended 2014, over the five years ending December 31, 2014, 84% of domestic equity funds failed to beat the S&P benchmark. On the fixed income side, 73% of managed fixed income funds failed to beat related indices."

Additionally, Hooke and Walters also said that some states may not even know what they are paying in fees.

"Based on our work, we conclude that a number of states are not reporting fees properly," they wrote. "Misreporting may be a particular problem with private equity and hedge fund investments, where managers often deduct fees before sending cash returns. California's Public Employees' Retirement System admitted as much in June 2015, when it said tracking such fees was complex."

This isn't the first time the issue has come up, the New York Times reported that New York City's public pension funds paid $2.5 billion in fees last year, which drew some criticism, even from the NYC comptroller's office.

According to the paper, Missouri's fund pays the highest in fees, according to the researchers analysis, at 1.70%. Following in the top 5 are South Carolina (1.56%), New Jersey (0.76%), Maryland (0.73%), and Oregon (0.68%).