The Teachers Retirement System pension fund is now $46.2 billion in the hole, only 76.9 percent funded. Had the managers chosen the simplicity of Couch Potato investing 10 years ago, the pension would be $18.4 billion closer to fully funded.
That’s quite a difference.
I learned this while examining the latest report from the largest public pension fund in our state. Then I measured it against the simple, low-cost index fund investing method I have advocated for nearly 30 years.
The report puts a good face on the results for the year ending August 31, 2018. It notes that the 8.2 percent return for the 2018 reporting period is higher than its target return of 7.6 percent.
But here’s the reality. Another year of complexity, alternative investments and hedge fund commitments has increased the annualized return gap between the pension fund and Vanguard Balanced Index fund (Admiral shares) over the trailing 10-year period.
In the 10 years ending August 31, 2018, the fund earned an annualized 7.1 percent. During the same period the Vanguard Balanced Index fund (Admiral shares) earned 8.34 percent. That’s a stunning difference: 1.24 percent a year.
In the previous 10-year period, ending August 31, 2017, the gap was an annualized 0.97 percent. Although lower, that’s still enough to be concerning.
While the TRS pension beat Vanguard Balanced Index by 3.09 percent in 2017, it trailed by 3.21 percent in 2018. That difference, plus rolling forward a year, is responsible for the larger long-term gap.
Will the gap change in the future? You bet. But the performance gap, whatever its size, is persistent enough to raise rude questions.
Such as, should the fund be managed in the same way in the future? Is it reasonable to bet so much on costly, illiquid alternative investments and hedge funds?
These are not philosophical questions.
If you’re one of the 1.6 million Texas primary, secondary and university level teachers covered by the plan, you have an obvious interest in a well-funded pension.
But don’t stop reading if you’re not. We all have a dog in this hunt. It may affect our future taxes. It could affect the education of our children or grandchildren. It could affect the future of Texas.
This is a big deal. Education is the building block of human capital. And human capital, as I pointed out in a recent column, is 10 times as important at financial capital. Texas needs to build its own human capital. To do that, Texas needs to attract and retain teachers at all levels.
But let’s get back to the money.
If you had invested $1,000 in the Teachers Retirement System pension fund 10 years ago and earned its 7.1 percent annualized return, your original investment would have been worth $1,986 at the end of the period. Had you invested the same amount in the Vanguard Balanced Index fund, your investment would have been worth $2,228.
That’s 12.2 percent more. Applied to the reported TRS fund balance of $154.1 billion, the fund could have been worth $169.6 billion. That’s $18.4 billion more. No one would call that chump change.
Indeed, that $18.4 billion is forty percent of the $46.2 billion unfunded actuarial accrued liability announced in the most recent report.
It’s important to note here than the Vanguard Balanced Index fund isn’t some far-out, weirdo investment vehicle. It’s a traditional 60/40 mix of domestic stocks and bonds, the mix used by pension funds and endowments for decades. It’s super bland, a mix that many, perhaps most, professionals would call unsophisticated or naïve.
It invests in the Vanguard Total Stock Market Index fund and the Vanguard Total Bond Market Index fund. So it represents the entire stock market — big cap, small cap, value stocks and growth stocks. It also represents the entire domestic bond market – Treasurys, mortgage-backed securities and corporate bonds. Both funds cost nearly nothing to manage. Both are highly liquid. They are investments in America and American business investments in the rest of the world. It’s the whole nine yards.
Instead, the pension fund has moved increasingly from liquid investments to high-expense alternative investments that have limited liquidity. According to the Pension Review Board analysis of the fund, for instance, alternative investments were 14 percent of net total assets in 2008 but are now 42.1 percent.
The best known alternative investments are hedge funds of all kinds and private equity funds. But they can also include managed futures, venture capital, direct investments in startups, private companies and investment in real assets such as real estate, oil, timber and agricultural land. The Yale endowment famously achieved superior returns with the early use of such investments. Followers, however, have not been so fortunate.
Nor is the commitment to alternative investments complete. On page 56 of the TRS comprehensive annual report, we learn that the fund has $32.3 billion in “unfunded capital commitments.” So another 21 percent of current fund assets are destined for high-fee, limited liquidity investments.
The comprehensive annual report provides thoughtful reasons for this, laying out its sophisticated case for global equity, stable value, real return and risk parity investments.
But simplicity and low cost would have been worth $18.4 billion more.
| The Teachers Retirement System of Texas
vs. Vanguard Balanced Index Fund |
|||
| This table compares the annualized returns of both funds over the 10, 5, 3 and 1 year period ending August 31, 2018. All figures vary from year to year and will vary in the future. | |||
| Investment Period | TRS | VBIAX (60/40) | Annualized Performance Gap
|
| 10 years | 7.1% | 8.34% | 1.24% |
| 5 years | 8.8 | 9.49 | 0.69 |
| 3 years | 9.4 | 10.14 | 0.74 |
| 1 year | 8.2 | 11.41 | 3.21 |
| Sources: 2018 TRS Annual, www.portfoliovisualizer.com | |||
Correction and Note to Readers:
The performance of the Teachers Retirement System pension fund was reported incorrectly in an earlier edition of this column. The 10-year annualized return was reported as 9.95 percent. The correct figure is 8.34 percent, a significant difference. Any related figures have been corrected. All other return figures were correct.
The TRS pension still trails investing in a balanced index fund by an annualized 1.24 percent. It’s also larger than the 0.97 percent gap in the previous 10-year period.
The change means that index investing would not have closed the entire unfunded liability gap of $46.2 billion. Instead, the recalculated additional return of $18.44 billion would have covered 40 percent of the gap.
My suggestion — that Texas teachers would be better served by low-cost index fund management than by management fees that cost over $1,270,065,736 a year — still holds.
Related columns:
Scott Burns, “The Simplicity Manifesto,” 3/31/2019 https://scottburns.com/the-simplicity-manifesto/
Scott Burns, “Can Couch Potato Investing Do Better Than the Teachers Retirement System of Texas?,” 9/16/2018 https://scottburns.com/can-couch-potato-investing-do-better-than-the-teachers-retirement-system-of-texas/
Scott Burns, “Couch Potato Investing versus Texas state pension funds,” 10/6/2018 https://scottburns.com/couch-potato-investing-versus-texas-state-pension-funds/
Scott Burns, “Local pension fund performance: All the Wrong Monkeys,” 11/26/2018 https://scottburns.com/local-pension-fund-performance-all-the-wrong-monkeys/
Scott Burns, “Mathematically Blonde,” 5/12/2019 https://scottburns.com/mathematically-blonde/
Scott Burns, “On the importance of being a dull investor,” 9/29/1991 https://scottburns.com/on-the-importance-of-being-a-dull-investor/
Sources and References:
Teachers Retirement System of Texas, 2018 Summary Annual Report, https://www.trs.texas.gov/TRS%20Documents/cafr_summary_2018.pdf
Teachers Retirement system of Texas, 2018 Comprehensive Annual Report, https://www.trs.texas.gov/TRS%20Documents/cafr_2018.pdf
Teachers Retirement System of Texas, 2017 Summary Annual Report, https://www.trs.texas.gov/TRS%20Documents/cafr_summary_2017.pdf
Texas Comptroller Office Public Pension Search Tool: https://comptroller.texas.gov/application.php/pension
Texas Pension Review Board, Public Pension Data Center https://data.prb.texas.gov/plans/327.html
Morningstar report on Vanguard Balanced Index, Admiral shares https://www.morningstar.com/funds/xnas/vbiax/quote.html
Morningstar report on Vanguard Total Stock Market Index, Admiral shares https://www.morningstar.com/funds/xnas/vtsax/quote.html
Morningstar report on Vanguard Total Bond Market Index, Admiral shares https://www.morningstar.com/funds/xnas/vtsax/quote.html
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo: Teachers Retirement System
(c) Scott Burns, 2019