Texas Teachers Retirement System Pension fund: Is it working for teachers and taxpayers?

The 5.2 percent earned by the Texas Teacher Retirement System pension fund in the fiscal year ending Aug. 31, 2019, isn’t impressive on its face. It’s lower than the previous year, for one thing. It’s also below the fund’s target return.

But 5.2 percent looks pretty grand when you compare it to the second largest public pension plan in the state. The Employees Retirement System of Texas pension clocked in with a dismal 3 percent. That superiority wasn’t a one-shot deal, either. The TRS pension fund also beat the ERS pension returns over the trailing three- and 10-year periods.

How about the other state and local pension plans in Texas? Sorry, that’s hard to tell. While the pension database on the Comptroller of Texas website lists all 99 plans and their trailing returns, plan reporting dates differ. So true apples-to-apples return comparisons for the same time periods aren’t possible from available data.

But measured against the other plans whose fiscal years close Aug. 31, the TRS tromps the competition in all three time periods.

Is beating the local competition enough?

So Texas teachers should be happy and proud, right?

Maybe. Maybe not.

Let’s consider a broader context.

Here’s the situation. The TRS pension fund puts an army of investment managers to work with the single-minded goal of achieving the targeted 7.25 percent return. Do that, and teachers will have the retirement income they’ve been promised.

So, the fund has investments in lots of asset classes. It also has investments in alternative assets, such as hedge funds of all kinds, private equity and natural resources.

To put it in precise, technical terms: They have investment products and talent out the wazoo.

The high cost of investment talent

But variety and talent don’t come cheap. Indeed, according to the Comprehensive Annual Report, compensation and incentives for fund managers clocked in at a cool $1.3 billion for the year. That’s about 0.83 percent of fund assets, a rather high amount for a fund with $157.4 billion in assets. The fund spent an additional $62.5 million on brokerage commissions.

You can find out why the TRS pension costs are so high on Page 111 of the Comprehensive Annual Report. More than 90 percent of the management fees go to those “alternative investments.” These are intensely managed investments best known for their high fees. In addition to a high basic fee, they take a hefty percentage of the profits. Warren Buffett has described such fees as “obscene.”

Yet, in spite of their lurid expenses, the TRS fund has nearly half its assets, $72.2 billion, in such funds. It has also committed an additional $36.9 billion to such investments in future years, a fact you’ll find on Page 56 of the report.

Following the trend

TRS is far from alone. Pension funds and endowments across the country have been investing in hedge funds/alternative assets for years. One reason is that many managers believe regular assets, like stocks and bonds, won’t produce the returns they need. If TRS is making a mistake, it will have lots of company.

In the context of conventional thinking in the investment world, expensive hedge funds are the way to go.  There are two major reasons for this.

The first reason is that it supports a belief that investment skills and smarts can bring good results. If the managers didn’t believe that, they would need to find another profession. It would probably pay far less.

More than half a century of studies and evidence, however, has found that good performance is, well, a random event.

The second reason will concern teachers and taxpayers.  Believing in high returns from alternative investments eliminates the politically horrifying need to tell the Texas Legislature that the 7.25 percent return goal won’t be met.

The only alternative? Increase the cash contributions from teachers, school systems and the state Legislature.

Messengers have been shot for less.

Performance depends on the measuring stick used

But let’s get back to context.

Investment managers love being measured against other investment managers. That makes it like a game of musical chairs. The folks with the worst returns lose their jobs, but everyone else remains happily employed.

Things look quite different when you change the measuring stick. The one I have used for decades is low-cost index investing.

It’s easy to do. We simply compare TRS fund returns to the performance of the Vanguard Balanced Index fund. And since we’re going to invest more than $10,000, we can put that $157.4 billion into the still lower cost Admiral shares of the fund.

That will cost 0.07 percent a year.

The TRS vs. Balanced Index Fund Scorecard

As you can see from the table below, Vanguard Balanced Index Admiral shares provided a higher return than the TRS pension fund – for all of its intense management – over the last year, three-year, five-year and 10-year reporting periods. I also compared the returns in each individual year of the last 10 and found that Vanguard Balanced Index Admiral shares provided a higher return in six of the 10.

What could all that money spent on management do for teachers?

The superiority of low-cost index investing suggests that a lot of money for teacher retirements is being syphoned off into the pockets of well-meaning and very well-paid investment managers.

So, let’s ask a trustee-like question. What if that money went to teachers? What would it do?

We can get an inkling by answering a simple question. How many years of average teacher pension income could all that management expense buy?

Here’s the math.

The average teacher monthly life annuity payment in 2019 was $2,096. That’s $25,152 a year. Divide that number into the $1,305,067,683 spent on investment management and you get 51,887 additional years of teacher retirement income.

Yes, you read that right: 51,887 years of pension income.

My bet is the investment manager trustees at TRS have never thought about it this way.  Maybe some other people in Austin should.

Next: Visiting the other 98 state and local pension plans in Texas

Related 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:

Erik Schatzker, “CALPERS CIO Eyes More Private Equity, Leverage to Boost Returns,” 6/15/2020   https://www.bloomberg.com/news/articles/2020-06-15/calpers-cio-eyes-more-private-equity-leverage-to-boost-returns

Jackie Wattles, “Warren Buffett Beat the Hedge Funds, Here’s How,” 2/24/2018   https://money.cnn.com/2018/02/24/investing/warren-buffett-annual-letter-hedge-fund-bet/index.html

TRS Fact Sheet, “Why did the TRS board of trustees lower the investment return assumption?”  https://www.trs.texas.gov/TRS%20Documents/ira_fact_sheet.pdf

Teacher Retirement System of Texas, 2019 Comprehensive Annual Report https://www.trs.texas.gov/TRS%20Documents/cafr_2019.pdf#search=Fiscal%20Year%202019%20Annual%20Report

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

Pension Review Board, Public Pension Data Center  https://data.prb.texas.gov/plans/327.html

Morningstar: performance figures for Vanguard Balanced Index fund, Admiral shares   https://www.morningstar.com/funds/xnas/vbiax/performance

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