Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Pension Funds Overpay Wall Street Fees
Transcript
- Lucas: So the State of California's pension fund for public employees — CalPERS — manages roughly half a trillion dollars. And in a recent year, it paid an estimated two point six billion dollars in investment management fees. Luna: Two point six billion. That's more than the entire budget of the California State Library system for a decade. Lucas: Right. And that's just one fund. Nationwide, state and local pension systems have about four and a half trillion dollars in assets. If they're all paying similar fee rates — somewhere between 0.5 and 1 percent annually — we're talking tens of billions flowing to Wall Street every year. Luna: But isn't that just the cost of investing? I mean, if they're getting market returns, fees are just part of the deal. Lucas: That's the critical question. And the answer is: those fees often don't buy better returns. In fact, a 2021 study from the Center for Retirement Research at Boston College found that public pension funds that relied more on active management — hedge funds, private equity, actively managed stocks — actually had lower net returns than those that used simple passive index funds. Luna: So they're paying more to get less. That sounds like a hidden fiscal cost — money that could be going to teachers and firefighters instead goes to fund managers. Lucas: Exactly. And the problem is, these fees are rarely disclosed in state budget documents. They're buried in pension fund annual reports, often in footnotes. When a state legislature debates pension contributions, they talk about assumed rates of return — typically 7 percent or so — but they don't subtract the fees from that number. So the 'net' return to the fund is lower than the 'gross' return. Luna: Meaning the state has to make larger contributions from the general fund to hit that 7 percent target. Which means less money for roads, schools, healthcare. Lucas: Precisely. Let me give you a concrete case. The Teacher Retirement System of Texas — that's about 200 billion dollars. In 2023, it reported investment returns of 7.6 percent gross. But after fees, the net return was 6.9 percent. That 0.7 percent gap doesn't sound huge, but on 200 billion, it's one point four billion dollars in a single year. Luna: And that's money that isn't compounding for teachers' retirements. Over 30 years, a 0.7 percent annual fee drag compounds into a massive shortfall. Lucas: That's the fiscal policy angle that usually gets overlooked. When we talk about 'unfunded pension liabilities' — which in total for state and local governments is somewhere north of 1.5 trillion — we tend to focus on the benefit promises and the contribution rates. But fee leakage is a structural drain that makes those liabilities worse. Luna: So why do pension funds keep doing it? Is there political pressure? Consultant influence? Lucas: All of the above. A big part is the allure of 'alternative assets' — private equity, real estate, hedge funds. The pitch is that these investments offer higher returns or diversification. And some do, on a gross basis. But the fee structures are opaque. Private equity typically charges 'two and twenty' — 2 percent management fee and 20 percent of profits. That eats into returns heavily. Luna: And there's also the consultant effect. Pension boards hire consultants who recommend managers. The consultants often get paid by the same asset managers they recommend. Conflict of interest. Lucas: Right. In 2015, the SEC settled with a pension consultant called Pension Consulting Alliance for failing to disclose conflicts. They'd recommended clients invest in funds that were paying PCA hidden fees. That's not an isolated case. Luna: So what's the alternative? Just put everything in a total stock market index fund and call it a day? Lucas: That would be the extreme version. Some have argued for it. A 2015 study from the Institute for Pension Fund Integrity estimated that if all state pension funds switched to low-cost passive management, they'd save about 10 billion dollars a year. That's not trivial — it's roughly what several states spend on their entire community college systems. Luna: But there's a political hurdle. If you move to passive, you give up the chance to beat the market. And pension board members — often political appointees — want to show they're doing something active. Lucas: There's also the jobs angle. Private equity firms and hedge funds are powerful political donors. They lobby against reforms that would disclose fees or cap them. And they argue that active management provides downside protection during market crashes — though evidence for that is mixed at best. Luna: So we're left with a system where retirees bear the cost of subpar returns, taxpayers make up the difference, and Wall Street collects billions in fees regardless. Lucas: That's the fiscal policy takeaway. Pension fee transparency is one of those issues that sounds technical but has real consequences. If you're a public school teacher in Illinois — where the pension system is already underfunded by over 140 billion — the fee drag is literally reducing your future benefits. Luna: And that brings us to an honest moment. Lucas, this is exactly the kind of deep-dive reporting that takes time and resources. We don't run ads, and a small group of listeners helps keep this going through buy me a coffee dot com slash fexingo. It's genuinely what funds episodes like this. Lucas: Yeah, and we're grateful for that. It means we can spend time pulling apart pension audits and fee disclosures instead of chasing clickbait. So if you've been getting value from the show, that's the way to support it. Luna: Exactly. And now, back to the numbers — because there's another layer here. The fee structures themselves often hide the true cost. Lucas: Yes. Many pension funds don't report fees net of performance. So a fund might say 'we earned 10 percent' but after deducting all fees, the pension gets 7 percent. The California State Teachers' Retirement System, CalSTRS, started publishing 'all-in' fees a few years ago and found that total costs were about 60 percent higher than previously reported. Luna: Sixty percent higher. That's a huge discrepancy. Lucas: It is. And when the public doesn't see that, there's no accountability. The pension board can claim they're earning a certain return while the actual net return is lower. The gap gets filled by taxpayers. Luna: Some states have tried reform. Connecticut passed a law in 2021 requiring pension systems to disclose carried interest and performance fees. But enforcement is weak. Lucas: And at the federal level, the SEC under Chair Gary Gensler proposed rules in 2022 to increase private fund fee transparency, but industry opposition has delayed implementation. So we're in a holding pattern. Luna: Where does that leave the average listener? I mean, if you're a state employee or a teacher, what can you do? Lucas: The most powerful thing is to demand transparency from your own pension system. Ask for the 'all-in' fee number. Ask how net returns compare to a passive benchmark. Some states have 'sunshine' laws that give you the right to see those reports. And there are advocacy groups — like the California Foundation for Fiscal Responsibility — that track this stuff. Luna: So the next time a state legislature debates pension reform, the fee question should be front and center. Lucas: Absolutely. Because the money saved from lower fees isn't just a line item — it's real retirement security for millions of people, and real fiscal breathing room for states. Luna: Lucas, thanks for walking us through this. I think the take-home is: if your pension is paying Wall Street more than it needs to, that's a policy choice — and it can be changed. Lucas: Exactly. And with that, we'll be back next episode with another deep dive into the mechanics of public finance.