Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Pension Funds Are Investing Like Hedge Funds
Transcript
- Lucas: So I was looking at CalPERS — the California Public Employees' Retirement System — and something jumped out. They now have nearly 40 percent of their portfolio in what they call alternative investments. Private equity, real estate, infrastructure, hedge funds. That's up from maybe 5 percent in the early 2000s. Luna: Forty percent. That's a huge shift. I mean, these are traditionally really conservative pools of money — they're supposed to be boring. Lucas: Exactly. And it's not just CalPERS. Public pension funds across the country — from New York to Texas to Pennsylvania — they've all been marching in this direction. The logic is simple: after the 2008 crisis, interest rates collapsed, and bonds stopped delivering the returns these funds need to stay solvent. So they went hunting for yield in private markets. Luna: Hunting for yield, but also hunting for fees, right? Private equity and hedge funds charge a lot more than a simple index fund. Lucas: Right — and that's the tension. If today actually made something click about how your state pension money is being managed, the way these episodes stay ad-free is listener support. You can find us at buy me a coffee dot com slash fexingo. No pressure — just a way to keep this kind of digging going. Luna: Yeah, it makes a difference. So back to the fees — what are we talking about? Lucas: Well, a typical public pension fund might pay 0.5 to 1 percent in fees for a traditional stock and bond portfolio. On alternatives, you're looking at '2 and 20' — 2 percent management fee plus 20 percent of the profits — though institutional investors often negotiate that down. Still, the total fee bill for a fund like CalPERS runs into the billions annually. Luna: Billions. And the argument for it is that these investments deliver higher net returns, right? That the alpha justifies the cost. Lucas: That's the argument. The data is... mixed. A 2021 study from the Center for Retirement Research at Boston College looked at public pension funds and found that, on average, their private equity returns didn't significantly outperform public equities after fees. But the dispersion is huge. Some funds have great managers, others get clobbered. Luna: And there's also the liquidity issue. When a pension fund needs cash to pay retirees, they can't just sell a piece of a private equity fund the next day. They have to plan years ahead. Lucas: Right. That's become a real concern. A few years ago, CalPERS had to increase its cash holdings because they realized they had too much locked up in illiquid assets. They needed liquidity to meet benefit payments. So you have this irony: chasing higher returns to close a funding gap, but creating new risks in the process. Luna: And it's not just financial risk — there's political risk too. Some state legislators have started pushing back. There were bills in a few states requiring pension funds to disclose fees more transparently. Lucas: Yeah, and that disclosure is a whole other can of worms. Private equity funds often argue that fee details are proprietary. So pension funds will release aggregated fee numbers but not fund-by-fund breakdowns. Critics say that makes it nearly impossible to assess whether the high fees are worth it. Luna: And then there's the whole question of whether pension funds even have the in-house expertise to evaluate these complex investments. CalPERS has a big internal team, but smaller state funds might rely heavily on consultants, which adds another layer of cost. Lucas: Absolutely. A survey a few years back found that among public pension funds with less than $10 billion in assets, very few had dedicated private equity staff. They were outsourcing the decision-making. And that raises accountability questions. If a consultant picks a fund that underperforms, who's responsible? Luna: So what's the alternative? If bonds don't yield enough and alternatives have high fees and risks, what should pension funds do? Lucas: That's the multi trillion dollar question. Some argue they should simply accept lower returns and increase contributions from taxpayers or employees. Others say they should be more aggressive — but in public equities, not private, since public markets are more liquid and transparent. A third camp says they need to improve their internal capabilities to do alternatives well, rather than just piling in blindly. Luna: And there's no one-size-fits-all answer. But the trend is clear: alternatives are now a permanent part of the public pension landscape. Lucas: I think that's right. Even if the pace slows, we're not going back to the 90s when a pension fund was 60 percent stocks, 40 percent bonds and that was it. The genie is out of the bottle. The question is whether the industry learns from the last decade and gets smarter about governance, fee transparency, and liquidity management. Luna: And whether taxpayers and retirees end up better off as a result. Lucas: Exactly. We'll be watching.