Maryland’s public pension system missed its annual target for returns by more than six percentage points in fiscal 2016, marking the second consecutive year that the retirement program fell short of its goal.
The $45.5 billion investment portfolio earned 1.16 percent after fees for the fiscal year that ended June 30, well below the fund’s annual objective of 7.55 percent, according to a news release from the State Retirement and Pension System. In 2015, growth was 2.68 percent.
Pension funds across the nation are struggling to meet their targets, despite paying large fees to high-cost financial experts who say they can beat the markets by actively managing investments.
In fiscal 2014 and 2015, Maryland paid more than $300 million to such professionals.
The state’s pension system has not determined how much it paid for management fees in fiscal 2016, but the agency plans to provide those numbers to the General Assembly’s joint committee on pensions around November.
Some financial analysts say pension plans should pull their money from actively managed funds and shift to passively managed index funds, such as those that track the Standard & Poor’s 500-stock index.
Jeff Hooke, a senior lecturer at the Carey Business School at Johns Hopkins University, has argued for years that indexes often perform better than actively managed investments such as hedge funds, and that they’re less risky.
He pointed to a Vanguard index fund that earned about 4 percent in fiscal 2016 as an example of a passively managed fund that outperformed Maryland’s portfolio, which consists of about 79 percent actively managed investments.
“Pension funds might be at a crossroads,” Hooke said. “The pensioners and taxpayers and pension boards have to reflect on whether to go with a low-cost strategy with average returns or to double down on the riskier assets.”
A few states have begun transitioning away from actively managed investments.
Nevada, for instance, has switched almost entirely to passively managed funds since 2014, indexing 100 percent of its mutual-fund and tradable-
securities portfolios. The state’s pension system ended fiscal 2016 with a 2.3 percent return, which was below its long-term target of 8 percent.
Andrew C. Palmer, chief investment officer for the State Retirement Agency, argues that Maryland’s actively managed investments help diversify its portfolio and minimize volatility. He added that low-fee indexes, which largely consist of stocks, tend to experience dramatic dips and spikes.
Maryland’s latest returns raise the prospect that the state and its public employees will have to contribute more money to the pension program to help fulfill its promises. The retirement system covers more than 382,000 active and former state employees, including firefighters, judges, state police and teachers.
“The risk to pensioners is that you could end up like Illinois or Pennsylvania, where the unfunded liability was allowed to increase,” Hooke said. “The legislatures in those states didn’t pay much attention, and those funds are only about 50 percent funded now.”
Other states fared worse than Maryland this year. The California Public Employees’ Retirement System reported a 0.61 percent net return on investments for fiscal 2016, and the New York State Common Retirement Fund earned 0.19 percent. Each invests in a mixture of actively and passively managed funds.
Maryland pension officials said they are confident that the state’s existing strategy will keep the retirement system healthy in the long run.
“While this is a very disappointing one-year return, it’s important to remember that we are long-term investors, meaning we should not be distracted by a single year’s performance, whether the earnings are high or low,” said Maryland Treasurer Nancy K. Kopp, who chairs the pension system’s board of trustees. “Over the last 30 years, including both good years and bad, the fund has earned an average return of 8 percent.”
Kopp has ordered an internal review of the program based on the low returns, with the report expected to go to the legislature’s joint pension committee in the fall.
Del. Ben Barnes (D-Prince George’s), who chairs the House subcommittee that oversees the retirement program, said he “looks forward to a full analysis and report . . . including consideration of any changes that may be necessary.”
Sen. Andrew A. Serafini (R-Washington), a member of the joint committee, has called for the state to switch from its current pension system, which promises a certain payout to public employees based in large part on their years of service, to a “defined contribution” plan similar to the 401(k) programs that many private employers offer.
“It’s what 90 percent of the country is using, and you don’t have these arguments over whether we should be using indexes, or can we pick the best people to manage investments, or can we outperform the markets as a state,” he said.
Defined-contribution programs give employees more control over how to invest their money and allow them to keep their earnings if they move from one job to another, but they also leave their funds entirely at the mercy of the markets.