It may be politically unpopular to say this, but the investment staff at public pension funds should be paid more. Much more.
This can be a hard argument to make, because pension investment managers generally make much more than the public employees whose pensions they help provide. For example, teachers' average annual pay, even in the highest paying states, is generally below $90,000, while a portfolio manager at a public pension plan can earn over $200,000.
But that is the wrong comparison. The right comparison is to the market. What can the pension investment officer be paid elsewhere?
If you were responsible for the investment of over $400 billion, but you were losing key employees, what would you do? If you realized that you were not paying market rates to your investment professionals, what would you do?
The California Public Employees' Retirement System, Sacramento, the largest public plan in the United States, manages over $400 billion. It has suffered an exodus of senior investment talent in recent years. So, the CalPERS board has adopted a new peer-group benchmark and a new incentive program for senior investment executives. That program is designed to make CalPERS's compensation more competitive in the market for investment managers. That is the real market comparison — private investment professionals.
Pension funds should pay market compensation in order to enhance investment performance and retain key staff. That is what CalPERS is trying to do, it is what Canadian pension plans do, and that is what U.S. public pensions plans should do.
Canadian plans long ago understood that, by paying market compensation, they can retain people in their jobs and can help drive excellent investment performance. One example: The $400 billion Canada Pension Plan Investment Board, or CPPIB, manages assets for Canada's social security system and has a reputation as one of the world's most sophisticated pension fund investors. Last year, the five most senior positions at CPPIB paid an average of over $4 million each.
OK, perhaps CPPIB's most senior positions are not a "market" comparison. Let's have a look at the portfolio manager position. A portfolio manager can make as much as $200,000 at a public plan, but a recent study concluded that portfolio managers for mutual funds are paid an average of over $1.3 million.
Why should we care about this? What difference does it make? Well let's be clear: It stands to reason that better paid staffs are likely to perform better, and a study recently by the Pension Research Council of the Wharton School at the University of Pennsylvania, Philadelphia, concluded that higher pay for investment staff can increase investment performance by about a half a percentage point. For a plan managing $50 billion, that would be a difference of $250 million.
So who benefits if the investment performance is a half percentage point better? As it happens, the pension recipients are not the beneficiaries of better investment performance. In general, their pension is determined by a combined measure of years of service, salary and age. That pension stays the same no matter what happens with the investments.
In fact, the actual beneficiaries of better investment performance are the taxpayers — you and me.
When the investment staff performs well, the state or municipality is able to save on contributions to the pension plan and have more funds available to lower taxes or to spend on underpaid teachers or cops.
It is a shame that political leaders refuse to do this arithmetic. Instead of explaining to voters that better compensation will likely save taxpayer dollars, they frequently critique the current pay to score easy political points.
Last year, a paper creatively titled "Outraged by Compensation: Implications for Public Pension Performance" cited a newspaper article to highlight the problem Oregon faced in trying to bring its compensation to market levels: "Unspoken, but also politically inconvenient is the compensation (paid to) attract talent from the private sector. The state's existing investment officers are some of the best paid public employees, making an average of $200,000 a year. But Treasury officials quietly complain that staff is underpaid by industry standards, and bristle about having to explain and get approval from the Legislature to release performance-based pay each year. As Treasurer (Tobias) Read pleads: If we have the talent, we will be able to make the decisions better.'"
This paper also points out that about $300,000 in increased compensation can translate to about $50 million in higher returns. That is significant money put back into the pockets of taxpayers.
The "outrage" should not be that public investment staffs are paid too much. It should be that they are not paid enough.
Charles E.F. Millard, New York, is the former director of the U.S. Pension Benefit Guaranty Corp. This content represents the views of the authors. It was submitted and edited under Pensions & Investments guidelines but is not a product of P&I's editorial team.
