Examining the Trees in the Texas Pension Fund Forest

Some people talk money only when they speak about pensions. But pensions are really about people. So let’s start our exploration of the Texas pension forest with an amazing fact.

A few big trees and many small ones

There may be 99 pension funds for state and local workers, but only 10 plans account for most of the participants. The largest 10 plans account for 95.4 percent of all participants. The largest five plans account for 92.6 percent. And the largest two plans account for 72 percent.

It could be said that the Texas pension forest consists of about a dozen big trees and 87 saplings. The real giant, the proverbial “elephant in the room,” is the Teacher Retirement System. It has 59.5 percent of all participants.

The heavy-duty concentration of participants holds true for other measures. Take unfunded liabilities, the money needed to be certain the plans deliver their promised benefits. Nine plans have unfunded liabilities of at least $1 billion.

More than 90 percent of unfunded liabilities in only nine plans

Those nine plans account for 92.4 percent of all unfunded liabilities. Only two plans have unfunded liabilities exceeding $10 billion. They account for 71.2 percent of all unfunded liabilities.

When we try to measure pension health, however, the number of participants and the size of the unfunded liabilities aren’t very helpful numbers. You can, for instance, have a fund with a multitude of participants and a huge unfunded liability. But the unfunded liability per participant may be relatively small.

The Texas Municipal Retirement System, for instance, ranks third in unfunded liabilities. But it is 87 percent funded. It has unfunded liabilities per participant of only $18,000. The Teacher Retirement System, which is 76.4 percent funded, and the Employees Retirement System, which is 70.5 percent funded, each have unfunded liabilities of just more than $30,000 per participant.

The most common measure of health

The most common measure for the health of a pension fund is its funding percentage. Texas has only five pension funds that currently have more assets than necessary to meet their long-term payment needs – over 100 percent funded.

But the two largest funds (see above) are below 80 percent funded, the level at which funds draw attention and concern.

Concern turns to horror when you examine the disaster end of the scale. Texas has 13 pension funds that are less than 50 percent funded.  Of that number, six are less than 40 percent funded.

Either way, relatively few people are affected. The five overfunded plans have only 9,011 participants. And the six most underfunded plans have only 1,283 participants.

Which funds are most likely to be the ongoing problem that will get the most attention in coming years? The Paris Firefighter’s Relief & Retirement Fund may be the most underfunded pension in the state at only 30.5 percent, but police and firefighter pensions in some major urban areas are where underfunding will trash the social stability of Texas.

Watch out for the Dallas Police and Fireman’s pension

While there are quite a few plans with lower funding levels than Dallas, my bet is on the Dallas Police and Fireman’s Pension system as a source of future angst and conflict.

Its only 48.1 percent funded.

It’s short some $2.3 billion.

It leads the list with the greatest unfunded liabilities for each of its 10,592 participants – a stunning $220,253.

Think what such numbers can do to recruitment and retention.

Some people talk passionately of “defunding” the police and some of them forget the hard and gritty side of police work. In reality, the folks on the fast track to “defund the police” are the lame managers of some of the police retirement funds.

While Dallas is the only major urban area with police and firefighters pension funding under 50 percent, Austin clocks in at only 58 percent. Fortunately, the funding level for other major metro areas is good. Houston is 81.7 percent. It’s 88 percent for San Antonio and a whopping 113 percent for El Paso.

Pension promises are fulfilled in two ways. First, money is committed for long-term investment. Second, managers try to earn a reasonable return on that money. If it is likely that future returns will be lower than hoped, the only option is to find and invest more money.

No one likes that.

That makes return on a pension funds’ investments a very big deal.

And a big disappointment.

In their most recent one-year reporting period, only 15 of the 99 plans beat the Vanguard Balanced Index Fund, Admiral shares. The fund, a close relative of my basic Couch Potato fund, is 60 percent domestic equities, 40 percent domestic fixed income.

Over the last three-year reporting period for each pension fund, only 23 of the 99 plans beat the cheap, plain vanilla fund.

And over the last 10-year reporting period, only three of the 96 funds with 10-year records beat the low-cost index fund.

Yes, you read that right: 3 of 96.

If you do a simple (non-asset weighted) average of the 99 Texas pension plans, they trailed the Vanguard Balanced Index fund, Admiral shares, by 1.97 percent, 1.27 percent and 2.14 percent, annualized, over the corresponding one-year, three-year and 10-year periods.

Those are huge gaps.

Here’s a rough, ballpark calculation to show just how huge. The average 10-year return for funds with 10-year records was 7.35 percent. Had they grown by an additional 2.14 percent a year — the average amount by which they trailed the Vanguard Balanced Index fund — they would be 23.7 percent larger. That would have taken their average 71.2 percent funding level to about 88 percent.

We’d all be resting easier.

Does this mean Texas has somehow cornered the market for mediocre pension fund managers?

I don’t think so. While extreme shortfalls are about mediocrity or worse, the fundamental issue is management expense that can’t pay for itself, let alone provide superior performance. Experts have been observing this for more than half a century.

For a closer look at the largest public pension plan in Texas, see the first column in this series:

“Texas Teachers Retirement System Pension Fund: Is It Working for Teachers and Taxpayers?, 7/25/2020

Just as the Teachers Retirement System pension fund is knee-deep in expensive talent, so are many of the other pension plans. Similarly, many have significant commitments to high-expense hedge funds and private equity funds that are best known for having expenses large enough to defeat any reasonable net return goal.

Indeed, there is growing evidence that Texas isn’t unique at all. It’s run-of-the-mill, blandly representative of the country as a whole when it comes to investing its pension and endowment funds.

The most recent evidence, published in late July, comes from Richard M. Ennis. In “Endowment Performance,”the investment consultant with decades of experience examined the performance of domestic endowment funds over the last 11 years.

He came to three major conclusions:

• U.S. endowment funds consistently underperform, regardless of fund size.
• Alternative investments have been a drag on endowment performance.
• High spending on investment management by endowments has overwhelmed any opportunity for higher returns.

As I’ve shown in these figures for Texas, it’s clear that high expense management afflicts pension funds as well as university endowments.

Next Sunday: The Best and Worst of the Texas Public Pension Managers

Related columns:

In this series:

Scott Burns, “Texas Teachers Retirement System Pension Fund: Is It Working for Teachers and Taxpayers?, 7/25/2020  https://scottburns.com/texas-teachers-retirement-system-pension-fund-is-it-working-for-teachers-and-taxpayers/

Scott Burns, “Public Pensions in Texas: Seeing the Forest,” 8/02/2020 https://scottburns.com/public-pensions-in-texas-seeing-the-forest/

Earlier columns:

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 Beats TRS Pension Fund Again,” 6/22/19 https://scottburns.com/couch-potato-investing-beats-trs-pension-fund-again/

Scott Burns, “How much is that in Y-A-T-P-I-S?,” 7/7/2019 https://scottburns.com/how-much-is-that-in-yatpis/

Scott Burns, “The Simplicity Manifesto,” 3/31/2019  https://scottburns.com/the-simplicity-manifesto/

Sources and References:

Richard M. Ennis, “Endowment Performance,” 7/07/2020  https://richardmennis.com/blog/endowment-performance

Texas Public Pension Fund Database at the Comptroller of Public Accounts Office:  https://comptroller.texas.gov/application.php/pension

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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.

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(c) Scott Burns, 2020