Arthur Frankstein did not set to create a monster. He had the best scientific intentions. He hoped that a living creature, well, from body parts. As the story of Mary Shelley is, we learn that the use of Frankstein is badly eliminated.
Very few severe experiments began in 1911 in Massachusetts. It is from here that the first statewide pension fund came into existence in the United States. This proved to be a very successful experiment, but not without its own unexpected results.
Today, all 50 states maintain at least one statewide pension scheme. All but five have many statewide schemes. And then there are all cities and county plans. Jurisdiction with many pension schemes is the subject of this post.
Diversification is a cardinal theory of prudent pension fund management. The principle is written in the Fidusari law everywhere. Public plan trustees have been investigated in their efforts to diversify investment. They always establish an asset allocation scheme to diversify between asset classes. They appoint many investment managers. They use index funds. His returns are in the broad market index. For example, my study indicates that, on average, large public fund returns are one R2 98%with market people. Public pension funds are diverse to NTH degrees.
Diversification went to the haywear
Here is the place where things start getting sticky. Large public funds use more than 150 asset managers on average.[1] An east of efficient portfolio management is that investor Does not Use active managers for diversification, which can be done much more cheaply with index funds. It is expensive to rent the managers’ scades. My estimated public pension funds, for alternative alternative investment with their 35% average allocation and in 20% or less index funds, meet the investment expenses of 100 to 150 bps per year. And they reduce the market index based on the same amount. The trustees are getting their diversification, yes – but with a condolent disability.[2]
We made demons
Things get spoiled when there are many pension funds in the same jurisdiction. As a result, there is an excess amount for the real consolidation of all individual money, for this it has a lower-line effect on taxpayers. Consider a taxpayer in Los Angeles. Their taxation is affected by the performance of three city pension funds, one county funds and three statewide funds. Consolidated funds include more than 1000 actively managed portfolio with countless individual positions. One portfolio losers compensate the winners of the other; Hundreds of people invested bets cancels each other. The result is an unholy index fund, patched simultaneously without intention and gave birth to a monster of disabled diversification.
$ 5 trillions in the United States are public defined profit assets. I estimate that public plans ruin $ 50 billion per year through disabled diversification. Garbage already connects heavy burden of financing public pension schemes, which eventually falls on taxpayers.
What is the solution? Some states, such as Minnesota, have a state board of investment. Although Minnesota has many statewide pension schemes, their assets are aimed at investment. This is a step in the right direction. However, as mentioned, individual pension funds are incompetently diverse, so there is no assurance that only pooling the property of the plan will achieve the desired result. And the state boards of investment usually release local funds.
A solar option is to index public pension assets In factJumbo-shaped, government-run pension funds are working in a political golden fish bowl, which lacks comparative benefits as investors. Nearly without any cost converts passive investment game into one in which public funds may be continuously winners.
key takeaways
Public pension schemes can use index funds or can follow the market benchmark, but in fact, they:
- Still appoint hundreds of active managers
- Invest expensive alternatives
- End with total portfolio that mirrors the market but at a huge cost
[1] Obree, JP and K. See Wandrey. 2020. “Internal vs. external management for state and local pension schemes.” Center, Boston College for Retirement Research.
[2] See Anis, RM 2025. “Alternative investment dies.” Journal of portfolio management (Upcoming). https://papers.ssrn.com/sol3/papers.cfm?bstract_id=5163511.