(Bloomberg) - New York City Comptroller Brad Lander wants state lawmakers to increase the share of its pension assets that can be invested in more expensive and opaque asset classes like private equity that promise higher returns.
Lander is asking Governor Kathy Hochul and the legislature for authority to raise a cap on alternative assets -- which also include direct loans to companies and private real estate -- to 35% from 25% to maximize returns for the pension funds that hold $275 billion.
A provision in state law, known as the “basket clause” that sets the cap hasn’t been adjusted since 2006. Former Governor Andrew Cuomo vetoed a bill to increase the share to 30% in 2014.
The law “fails to reflect the realities of the modern investment world and hampers our ability to prudently diversify our portfolio, maximize our risk-adjusted returns, and save money in the long term,” Lander said in testimony Feb. 9 to a joint state legislative committee hearing on Hochul’s proposed budget.
If state lawmakers don’t want to increase the “basket clause” cap, Lander asked them to raise a limit on foreign stocks to 30% from 10%.
Spokespeople for Hochul, Mayor Eric Adams, Assembly Speaker Carl Heastie and Senate Majority Leader Andrea Stewart-Cousins weren’t able to provide immediate comment.
Yale Model
U.S. state and local government pensions, which count on annual investment gains of about 7% on average, have piled into illiquid alternative assets to cover pension shortfalls after a decades-long decline in interest rates and slower economic growth made it harder to meet long-term targets.
Private equity firms and hedge funds often charge investors fees of as much as 2% of money they manage and 20% of profits. New York City’s five pension funds paid investment managers about $1.2 billion in fees in the fiscal year ending June 30, 2021.
While public pensions have racked up blockbuster returns over the last two years -- fueled by massive fiscal and monetary stimulus -- many pension managers expect future returns to fall as economic growth slows.
U.S. public pensions increased their allocations to alternative investments to an average of almost 31% of total assets in 2020 from 15% in 2007, according to data provider Preqin. Many seek to emulate the “Yale model” pioneered by the David Swensen, the former chief investment officer of Yale University’s endowment.
Swensen favored allocating assets toward private equity, hedge funds and venture capital rather that stocks. Over Swensen’s 35-year stewardship, the Yale endowment generated annualized returns of 13.1%, beating a traditional portfolio of 60% stocks/40% bonds by 4.3% annually, according to the university.
High Fees
The largest two of New York City’s five pension funds -- the $104 billion teachers’ and $88 billion civil employees’ funds -- have earned an annualized return of 9.32% and 9.34% before fees for the 10-year period ending June 30, 2021.
By comparison, Vanguard Group’s Balanced Index Fund, which invests roughly 60% in stocks and 40% in bonds returned 10.3% annualized for the same period.
For pension funds’ that spend more than $1 billion on fees to Wall Street, “the results clearly are not all that good,” said Jeff Hooke, senior finance lecturer at Johns Hopkins Carey Business School and author of ‘The Myth of Private Equity’.
Between high fees and middling returns, alternative assets drain $30 billion per year from public pensions, according to Hooke.
New York City’s teachers’ and civil employees’ pensions’ private equity investments earned 12.25% and 11.5%, respectively, on their buyout, venture capital and “special situations” funds since the late 1990s. That’s about the same as they would have earned by putting the money into the Russell 3000, according to pension documents.
Their “opportunistic” fixed-income investments have underperformed their benchmark by 1.74% and 1.3% respectively, as of June 30, 2021.
By Martin Z. Braun
