Recently the office of Scott Stringer, New York City Comptroller, released a widely covered report confirming what many in the pension world have been realizing: High-priced investments in hedge funds and private equity have not only failed to beat the market but cost the city pension funds billions of dollars. The comptroller's report found that private equity investments were the worst performers, costing the city more than $2.6 billion over the past decade due to underperformance and astronomical fees that can be four times the fees of comparable investments.The city's hedge fund and actively managed stock portfolios performed slightly better than their benchmarks, but here, too, management fees consumed nearly all of the additional returns.
To the lion's share of Americans who don't have public pensions, this news might evoke frustration that Wall Street tycoons are soaking up billions in taxpayer money, but they otherwise view it as largely irrelevant to their own lives. However, this simply isn't the case: Public pension funds serve a unique role in our society, and their investments have a huge impact on all of us, not just on government employees.
The assets owned by public pension funds represent the largest pool of financial assets held by the public, and the size of this pool--more than $5 trillion--gives the public an important and influential channel of influence on the private sector as one of its largest investors, and they are using that influence to create a more equitable and sustainable private-sector economy. Using their clout as large shareholders, a coalition of public pension funds, unions, and others convinced at least 14 large firms, including Yum Brands, Citigroup, and General Electric, to allow shareholders to directly nominate candidates for their boards of directors, which will in turn allow the public a say on the wages, executive compensation, and other policies at these corporations. The coalition has submitted shareholder "proxy access" proposals at 75 other large firms, which, if successful, could lead to better jobs for workers across the private sector.
However, public pensions' investments in private equity and hedge funds are not similarly aiding private-sector workers. In fact, they're actually helping fuel rising inequality by propping up the grossly inflated compensation of managers at these firms, at the expense of the average worker. Hedge-fund managers were paid an average of $2.4 million in 2014, an increase of 8 percent from the year prior, while the average pay for private-sector workers is lower than it was in the 1970s.
The poor performance of private equity and hedge-fund investments documented by Mr. Stringer and others in actuality represents an opportunity for public pension funds to commit even more of their capital to investments that benefit public- and private-sector workers alike. How? Here's one idea. State and local pension funds had approximately $500 billion invested in private equity and hedge funds as of 2013. What if they instead invested that $500 billion in infrastructure?
Currently, public pension funds are effectively discouraged from investing in municipal bonds, which finance a large portion of infrastructure projects in the U.S., because funds can't benefit from the tax incentives that make municipal bonds attractive investments. If we were to create a mechanism that would allow public pension funds to profitably invest in infrastructure, the benefits could be enormous. According to the best estimates, $500 billion in infrastructure investment would generate more than 11 million middle-class jobs in sectors like construction, manufacturing, and telecommunications, in which employment has yet to recover from the damage of the Great Recession. The additional spending generated by these jobs would in turn add around more than $750 billion to GDP and help our economy remain competitive by buttressing a crumbling infrastructure system in desperate need of investment and repair.
Despite the benefits to our entire economy described here, public pensions have been under attack; in just the past four years, a majority of states made cuts to their pension systems, and many state pension systems remain underfunded, in large part due to inadequate state contributions. If we want public pensions to continue to use their unique clout to improve the economy for all of us, we need to do our part to reverse these trends. And pension funds help buttress public support by getting out of high-priced, inefficient investments in private equity and hedge funds and instead put their resources into investments like infrastructure that benefit all of us.