New York City Pension Seeks More Alternatives
New York City’s five public pension plans face very large deficits. Sadly, they’re promising the New York State Legislature that an increased allocation to hedge funds will help to fill the gap and provide more stability for the plans. I found the memorandum supporting the legislation (A. 9643, S. 7331) hard to read, because I’ve written the same sort of unsupported contentions during my career. The City’s Comptroller has asked the legislature to increase the pension plans’ catchall bucket from 25% to 35%. Since the pension plans have over $150 billion in assets, the legislative change could result in another $15 billion flowing into alternative investments.
Under New York’s pension statute, any investment that isn’t a conventional domestic or international stock (up to 10%) or domestic bond must fit into the catchall category. As best as I can tell, the City Employees pension is nearing a 23% allocation to its catchall bucket, so it is likely to near the 25% ceiling in the next year or so. The other City pensions have more leeway, but will approach the current limitation if they increase their allocation to hedge funds.
Aside from the bill’s rationale – to increase the pension plans allocations to alternatives –the legislation also highlights the problem with the “legal list” approach to investing public pension plans. Instead of instructing the trustee to invest as a prudent person, New York has asset class limitations set in the pension statute. The legal list is a vestige of the Great Depression. In the 1930s many states attempted to reign in risk by constraining the investments made by banks and insurance companies. In some states, this approach was extended to public pensions. There is little doubt that the prudent person standard which governs many public pension plans, all private plans, and endowments and foundations is a superior investment model.
The legal list guarantees that a pension plan will always be late in entering an asset class. Long after most pension plans had added equities to their pensions in the 1960s and 1970s, legal list pensions remained invested in bonds. They only added stocks in the late 1970s and 1980s. South Carolina didn’t add equities until the end of the last century. A similar delay took place for international stocks and real estate. By the time a legislature gets around to authorizing a new investment, it is usually late in the game. The best managers and best opportunities have already been exploited, and pension plans using the legal list approach obtain mediocre results.
In addition, the legal list adds another layer of politics to the investment process, and puts the question of asset allocation in the hands of people with limited or no expertise. The money management community will undoubtedly lobby for the change in New York City’s statute, and they will funnel contributions to the key players in the legislature. If nothing else, money managers are good at political influence. The increased campaign contributions will be a small price to pay, given the mother lode in additional fees made possible by the pending legislation.