STUMP » Articles » Public Pension Fund Governance: Who Are the Funds Being Managed For? » 24 October 2018, 13:19

Where Stu & MP spout off about everything.

Public Pension Fund Governance: Who Are the Funds Being Managed For?  


24 October 2018, 13:19

You would think this would be straightforward.

The funds should be managed for the benefit of the pension plan participants, right?

And yet…..


So a lawyer wrote a paper making the argument that public pension funds should be managed with the taxpayers in mind.

Legal scholar says public retirement stewards should prioritize taxpayers over retirees

A legal scholar who studies public and private investment funds says the people who are managing taxpayer-funded retirement plans are looking out for pensioners when they should be focused on what’s best for taxpayers.

Publicly funded retirement boards are responsible for directing pension investments. Historically, they’ve acted on behalf of the pensioners and soon-to-be-retirees that are paying into the fund. Ohio State University professor Paul Rose, who is Associate Dean for Academic Affairs at the Robert J. Watkins/Procter & Gamble Professor of Law, proposes that they should be acting on behalf of taxpayers because taxpayers are largely responsible for contributions and would be expected to foot the bill for any funding shortfalls.

In an article for the Illinois Law Review, titled “Public Wealth Maximization: A New Framework for Fiduciary Duties in Public Funds,” Rose said the shift of focus may not ultimately result in higher pension funding levels, but it would be acting at the behest of those who would ultimately face exposure to a fiscal downturn.

“Fiduciary duties should flow to the true risk-takers: the public – the current and future citizens and residents – who will ultimately benefit or suffer from the investment choices of the public fund trustees,” Rose wrote.

“The real residual risk bearers for the failure of the pension funds are really the taxpayers,” Rose said.

Here’s my really quick take: that would be true if government entities never go bankrupt and public pension benefits never got cut.

Except they do… and they do.

So I will put out a compromise position: if the public pension fiduciaries recognize that government can go out of business, can go bankrupt, and that pension benefits can be endangered by taxpayers not there to be soaked 10 to 20 years later, then following their fiduciary duty to the pension participants (both active and retirees) would also safeguard bondholders and taxpayers.

If they require full contributions, if they require appropriate investment of the funds, if they oversee risk management for the plans, then all the stakeholders will have their interests protected.

This is Prof. Rose’s law review paper.

I am not a lawyer, and I do not know if any public plan fiduciaries have been sued over dereliction of their fiduciary duty.

However, fiduciaries have been removed by those who get to choose the fiduciaries… and we saw that happen in California recently.


California Public Employees Vote Against Pension-Fund Activism

The California Public Employees’ Retirement System this month said no thank you to pension-fund activism. Government workers unseated Priya Mathur, the sitting Calpers president. She was defeated by Jason Perez, a police-union official who criticized Ms. Mathur’s focus on environmental, social and governance investing, or ESG. Mr. Perez emphasizes the agency’s fiduciary duty to maximize investor returns.

Calpers represents almost two million California public employees, retirees and families. Yet it mostly makes headlines for its activism, such as divestiture from the tobacco industry. “It’s been used more as a political-action committee than a retirement fund,” said Mr. Perez. “I think the public agency [employees] are just sick of the shenanigans.”

Americans have always invested to achieve personal goals, such as saving for a house or their kids’ college tuition. Some find that an ESG or issue-specific approach to investing accords with their personal philosophies. There is nothing wrong with people investing their own money however they like. But Calpers has a fiduciary duty to California public employees, who rely on it for retirement security.

Hester Peirce, a commissioner of the Securities and Exchange Commission, recently observed, “When a pension-fund manager is making the decision to pursue her moral goals at the risk of financial return, the manager is putting other people’s retirements at risk.” The danger for Calpers is real: In 2016 a consultant found that the fund’s beneficiaries missed up to $3 billion in investment gains from 2001-14. The reason? A divestiture from tobacco holdings for political purposes.
While Calpers beneficiaries are demanding a renewed focus on returns, activists continue to work other channels to impose agenda-driven requirements on public companies. Sen. Elizabeth Warren last month unveiled a bill that would direct the SEC to mandate that all public companies disclose fossil-fuel use and greenhouse-gas emissions. This month a petition signed by 17 law professors and institutional investors, including Calpers, asked the SEC to develop mandatory rules for public companies to disclose ESG information.

The petition argues that since there are already so many requests to the SEC for issue-specific disclosures — human-capital management, climate, tax, human rights, pay ratios by sex, and political spending — the agency should impose a broader ESG disclosure framework. The laundry list of possible disclosures underscores the problem. Requiring companies to account for an ever-changing list of hard-to-quantify social issues distracts from disclosure’s real, statutory purpose: giving the reasonable investor material information he needs to make investing decisions.

I believe all those requests to the SEC should be struck down. Period.

The SEC is there to protect investors from being defrauded, not to make sure whatever hobbyhorse current activists are riding will be made easier to become real horses (okay, this is a tortured metaphor).

Just stop it.


All of these issues devolve to the principal-agent problem, one well-known to business professionals everywhere, and a problem that regulation is often brought to bear to try to solve.

The principal–agent problem, in political science and economics, (also known as agency dilemma or the agency problem) occurs when one person or entity (the “agent”) is able to make decisions and/or take actions on behalf of, or that impact, another person or entity: the “principal”.1 This dilemma exists in circumstances where agents are motivated to act in their own best interests, which are contrary to those of their principals, and is an example of moral hazard.

Various governance strictures are often in place to try to align the interests of the agents with the interests of the principals.

In the case of the public pension funds, the obvious principals are the pension plan participants.

But these are not one amorphous bunch of folks: there are people already retired, who are currently receiving payments. They want to keep getting their payments, and they’d probably like some nice COLAs on top. There are people who no longer actively work for the employer(s) sponsoring the plan, but are not yet taking payments. They want to get those future payments.

These first two groups have little power against the sponsoring employers, as they can’t strike or negotiate contracts, no longer being active employees. For plans like Calpers, though, they can vote for pension board members. If they live in the states where their pension funds are, they can vote in/out people who bolster their pension benefits. Even if they’re out of state, they can donate to politicians who bolster their pension benefits.

The third direct principals are active employees. They can strike, they can negotiate pay contracts, etc. While they’d like to get their future pensions, they probably also would like to get higher pay right now. They don’t want their own contributions to the plans to rise too much, and if the sponsoring employer contributions go too high, they may not get current pay raises, and that makes them unhappy. These folks can also vote for pension board members at Calpers (not necessarily true at all public pension plans, but many do allow for employee representation on the board).

So of three pension plan principal groups, their interests are not perfectly aligned.

This is even before we consider the interests of politicians and taxpayers.


NASRA had a report on good governance structures for public pension funds, which has some good advice in there:

Six Principles for Effective Public Pension Fund Governance:

1. Effective and Capable Fiduciaries – The Board functions effectively, investments are
prudently selected and managed, the fund is operated cost effectively, customer service
and operations are high quality, and the fund is reliable as a source of information for
pension and benefit choices.

2. Ethical Leaders – The board and executive team share values, work together
constructively, and set the tone at the top. The Board and staff are free from conflicts
of interest and have credibility with regulators and legislators. The Board operates with
discipline and is self-policing. There is a culture of compliance with applicable laws,
regulations and organizational policies and there are clearly-established whistleblower
policies and procedures.

3. Open and Accountable to Stakeholders – The Board and executives are appropriately
open in the way key decisions are made and publicly disclosed. The organization
structure and processes provide clear lines of authority and responsibility. Effective
metrics are used to monitor strategic, investment, operational, financial and compliance
results. Executives are accountable for their performance, and their compensation is
directly linked to performance outcomes over appropriate time periods that reflect
agency goals and beneficiaries’ short- and long-term interests.

4. Risk Intelligent and Insightful in Decisions – The Board approves the risk preferences
and tolerances of the fund, and ensures the enterprise is prepared for low-probability
risks and long-term sustainability. An effective enterprise risk management framework
is used to consistently monitor and report aggregated risk exposures and the
effectiveness of mitigation and control. The management reporting process provides
insight, not just data, to enable the board to provide appropriate direction and advice to
management and fulfill its oversight responsibilities.

5. Long-Term View for the Needs of Beneficiaries and System Participants – The board
integrates short-term and long-term perspectives on both assets and liabilities to ensure
financial soundness and effective retirement solutions for members and employers. The
board is alert to long-term unintended negative consequences of short-term decisions
and maintains strategic flexibility to allow for uncertainty.

6. Continuous Learning and Adaptation to Changing Conditions – The Board conducts a
regular assessment of its performance and capabilities. A board self-development plan
addresses the continuous learning and development needs for all board members based
on a comprehensive and tailored individual development process. Performance
feedback is obtained through an annual board self-assessment process.

But reality often falls short of the ideal above.


Some of the issues that come up:

  • some pension board members are ex-officio members – politicians who definitely have other interests, many of whom are looking for higher office, or a cushy glide path post-office
  • employee and pensioner representatives on the board may not really have much financial expertise, and may not be able to detect fund mismanagement….and their interest may mainly be boosting pension benefits without regard to plan solvency

For the second (and even the ex officio members are not necessarily all that good in expertise), there is “board education”, but it can fall short… especially given who is in charge of educating the board — agents hired by the pension plan, often.

The board hires agents, whether it’s a permanent professional staff (as Calpers has), or it’s outside consultants (as many hire outside consulting actuaries, as an example, or asset managers).

I am going to use actuaries as the example — they’ve got a few interests of their own. Generally, continued employment. That is as an internal employee or as an external consultant. Their principals? The pension board or the pension fund management. The ones who hired them.

Not the pensioners.

Not the active employees.

And definitely not the taxpayers.

Mind you, there are actuarial standards of practice, which, if you don’t follow them, you can have your credentials yanked. That definitely can have an effect on continued employment.

And I could go into the myriad interests of the actuarial groups that set standards, but you could just look at this old post on actuarial brou-ha-has.

If the pension board or management tells the actuary to value the pension at 7.5%… the actuaries value at 7.5%.

But do the pension fund fiduciaries know whether 7.5% is appropriate or not?

And do they really pay if they screw up that decision?


As far as I know, absent outright criminality (as with the pay-for-play Calpers scandal), I have yet to hear of the public pension trustees getting yanked from boards… except with these type of direct board elections. And these sorts of upsets as have happened at Calpers has not been that frequent.

Generally, participants don’t look too closely at plan governance… until problems arise.

I’m happy to hear that Calpers participants are taking a close look at how their pension funds are being used as a political toy by various entities… including the state legislature, where the politicians there have no fiduciary duty to the plans.

But the Calpers participants have diluted influence in electing state legislators (especially if they no longer live in California). Retired participants’ main influence is via them electing their board representation. Good for them.

A few of my earlier posts on fiduciary duty:

Yes, a lot of these deal with divestment, and, sadly, a lot of these decisions are being made by people (mainly politicians) who are not fiduciaries at all.


So here we have a bunch of recent stories, mainly surrounding divestment, but also surrounding other political issues that have little to do with fund performance and good governance of the funds.

To be fair, most of the people who are asking for certain actions based on politics and not potential returns are not fiduciaries. I do not envy the fiduciaries who have to stand up to them.

But yes, some of the people making divestment decisions are fiduciaries.

It’s just not clear to me that they will suffer at all if they made a foolish decision.


As with yesterday’s post, I wrote most of this post last week. I’m taking a bit of a break for a while, and yes, I saw the Frontline material, and yes, I saw the three-part series at the Intercept.

For those who do not know what I’m talking about:



I will likely have something to say about this later.

But if you’d like some perspective from the numbers, here is a post on the Kentucky pension assets, in which I notice Kentucky ERS is in an asset death spiral, but not due to investment returns.

If one looks at the Kentucky pension liability post, you see the primary driver of Kentucky pension underfundedness is the obvious: grossly undercontributing to the pensions.

I will let John Bury have the last word:

[video: Over the years, private companies have largely stopped offering defined benefit pension plans, but most public employees still have them]

And why is that? Could it be because Defined Benefit plans are expensive in a low-interest rate environment and plan sponsors who have to come up with their own money and obey funding rules are reluctant to pay the honest cost?

Chasing yield via private equity/hedge funds was a way of avoiding having to pay the honest cost.

So they’ll end up paying in other ways.

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