Couch Potato Investing versus Texas State Pension Funds

Should we all be concerned about public pension funds in Texas?

Yes. Everyone. But some have more at stake than others.

Public employees have reason to be concerned, up close and personal. The need is obvious: If your pension fund is seriously underfunded, the pension income you expect may not be there when you retire.

But we’re all in this together

For those who live in Texas, even with no expectations of a public pension, some of how it works out may be coming out of your pocket. That’s what happens when government bills might be unpaid.  Usually the bill is paid with new or increased taxes.

How much and when? Well, that chapter has yet to be written.

A few weeks agoI wrote about the largest of the public pension plans in Texas – the Teachers Retirement System. With 1.5 million participants, it dwarfs all the others. Indeed, while there are seven state plans, TRS alone accounts for 60 percent of the 2.5 million workers covered by the seven plans.

Some fairly good news

TRS is in reasonable shape, slightly over 80 percent funded. According to the database of pension fund dataat the office of the Comptroller of Texas, the TRS has an unfunded liability of $35.5 billion. That’s about $23,000 per member. Of the seven state plans, three are better funded, one is about the same, and two are in materially worse shape.

Whether any of the funded ratios improve or get worse will depend on the future investment performance of these funds. Good performance can close some of the gap. Poor performance will make it larger.  Poor performance will require more contributions to make good on the promises.

This is real money

It’s important to note that we’re talking real money here, not just percentages. While most of the funded ratios are not causes for immediate alarm, it would cost about $62 billion to bring all these plans to full funding.  That’s more than twice the $28.9 billion Texas collected in sales taxes in 2017.  And it’s more than 50 times the $1.2 billion collected in alcoholic beverage taxes in the same year.

So how are they doing?

For the most recently reported 10-year performance figures, a simple low-cost index fund that I have often mentioned did better than every single one of the Texas plans.

A simple, basic index fund beat them all

Yes. Every fund. Not one or two. Not three or four. Vanguard Balanced Index Admiral shares (ticker: VBIAX) provided a higher return than any of the seven state public pension funds. The Teachers Retirement System fund trailed by the smallest amount, what appears to be about 0.96 percent, annualized, for a decade.

The worst performer, the Texas County and District Retirement System, with 294,243 participants, trailed the Vanguard fund by over 2 percentage points, annualized, for the decade. (Fortunately, this fund is still relatively well-funded, clocking in at 88.44 percent and an unfunded liability of $3.5 billion, or $12,000 a member.)

Here’s a list in descending order of funding:

Source: https://comptroller.texas.gov/application.php/pension/#skip-scroll

Now let’s take a look at their performance relative to what some might consider the canonical Couch Potato investment. Vanguard Balanced Index Fund is a traditional, conventional 60/40 mix of domestic stocks and domestic bonds. Its asset allocation has been common to bank trust departments for decades. The greatest innovation in this fund – and it is great – is that it costs next to nothing, a piddling 0.07 percent a year. In spite of that – or perhaps because of it – it clobbers the performance of every state pension fund in Texas.

Texas isn’t alone

The under performance of pension funds isn’t limited to Texas. Based on the 10-year returns I found in a Pew Charitable Trust study of state public pensions across the country, simple index fund investing would have provided better results than a large majority of state pension funds.

What most pension funds have in common

It turns out that Texas state pension funds have something in common with the pension funds in most other states.

They still believe that complex and expensive investment management will bring superior results. So they invest accordingly.

While the percentages vary from state to state, the Pew Charitable Trust studypoints out that virtually all pension funds have cut their holdings in stocks and bonds in recent years. At the same time they increased their holdings in alternative investments such as hedge funds and private equity firms.

Such investments, typically, are expensive to manage, illiquid and difficult to evaluate. Often, their after-fees returns to investors are a disappointment. As Warren Buffett said at the 2016 annual meeting of Berkshire Hathaway:

“There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities.”

But they hold out the catnip that institutional investors continue to seek: the possibility of higher returns, a chance of beating the market.

The result has been billions transferred to expensive managers and unfunded pension promises that will need to be paid. In terms of an old country and western song, the managers got the mine. Everyone else got the shaft.

On the web:

Can Couch Potato Investing Do Better Than the Teachers Retirement System of Texas, Scott Burns, 9/16/2018  https://scottburns.com/can-couch-potato-investing-do-better-than-the-teachers-retirement-system-of-texas/

Public Pension Search Tool, Comptroller of Texas   https://comptroller.texas.gov/application.php/pension

“State Public Pension funds — investment practices and performance, 2016 update”  https://www.pewtrusts.org/en/research-and-analysis/issue-briefs/2018/09/state-public-pension-funds–investment-practices-and–performance-2016-data-update

“Warren Buffett says hedge funds get ‘unbelievable’ fees for bad results,” livemint, May 2, 2016, Sonali Basak and Noah Buhayar  https://www.livemint.com/Companies/pJIWtCZZeS55e87zDaAHAP/Warren-Buffett-says-hedge-funds-get-unbelievable-fees-for.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:  Scott Burns: Darkening Sky East of Needles, CA from 1999 Borderland motorcycle trip

(c) Scott Burns, 2018