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Brett Arends's ROI

Oct. 6, 2020, 1:19 p.m. EDT

‘Pathological’ behavior by pension fund trustees leads to billions blown on real estate

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By Brett Arends


Finance professor Timothy Riddiough says some of the people running America’s 6,000 state and local public pension plans are exhibiting “pathological investment behaviors.”

No, really. Pathological . (At least, he says, from the perspective of classical financial economics perspective.)

These pension fund managers invest in the same assets, then hope to beat the market, he says. They take foolish bets to try to get out of their funding crisis, like gamblers hoping to win back their losses. They engage in “delusional benchmarking, giving themselves A’s and B’s for C and D work.”

Oh, and they are pouring somewhere nearing 10% of their members’ money into private real estate ventures that have a dismal track record and which they won’t be able to exit easily if they need to.

Like I said: Ouch.

Riddiough is a finance professor at the University of Wisconsin and an expert in real-estate investment trusts. He holds the department chair in urban land and real estate economics. And his comments matter not only for his expertise but because they come in an extraordinary and detailed takedown of public pension funds , especially their fondness for “private equity real estate” funds.

The National Association of State Retirement Administrators, the organization that represents the managers, disagreed.

“Public pension funds are long-term investors and invest in diversified portfolios that are intended to maximize investment returns within an acceptable level of risk,” the organization said in a statement. “As a group, public pension funds invest around 7% of their assets in real estate. As part of their required due diligence, public pension funds continually review their asset allocations and risk profiles to ensure they are optimizing risk and investment return.”

It added: “Although the report author accuses public pension fund managers of a ‘herd mentality,’ in fact, many public pension funds do not invest in real estate at all, and among those that do, there is a wide range in the percentage of their portfolio that is invested in real estate. Moreover, the author’s attempts to link growing pension underfunding to increased allocations to real estate are purely speculative: public pension funds have been diversifying their portfolios for many years after investing predominantly in just two asset classes: public equities and bonds. Such diversification is prudent and part of a sound investment and risk management strategy.”

In a nutshell, Riddiough cites detailed industry data showing that these private funds have underperformed publicly traded real-estate investment trusts, the kind anybody can buy on the stock market or through a money manager like Vanguard, by a country mile.

He also cites data showing there is no evidence any individual managers have any particular, persistent skill worth paying for.

Since reliable records began back in the late 1970s, these private REITs overall have trailed the ones available through the stock market by an average of more than 5 percentage points a year, according to industry data. Someone who had put their money in public REITs back then would today “be nearly 7-times better off” than someone who backed the private funds, he says.

Seven times better off.

Yet public pension funds keep buying them, year after year. State and local pension funds may now account for about half of all the money in these private equity real-estate funds. We’re talking tens, even hundreds, of billions of dollars.

These comments come just as Boston College’s Center for Retirement Research warns that public pension funds have just booked an absolutely terrible fiscal year (which is typically measured from July 1 to June 30). That, it adds, is even despite the massive stock market rebound in the spring, and the soaring prices for bonds.

Average returns during the fiscal year: 1.75%, or barely a quarter of targets.

Er…they could have made more than four times as much, or 8.1%, in Vanguard’s Balanced Index Fund /zigman2/quotes/208139840/realtime VBINX -1.18% over the same time. They managed to underperform the basic, ACWI global stock index, which gained more than 2% and which they could have owned through a single exchange-traded fund, like this /zigman2/quotes/208607471/composite ACWI -1.34% . And they were way, way behind things like long-term U.S. Treasury bonds /zigman2/quotes/201786083/realtime VUSTX -1.94% and TIPS /zigman2/quotes/207983017/realtime VIPSX -0.70% , which earned you better than 20%.

The pension funds’ target returns for the year averaged about 7.2%, Boston College calculates. Oops.

Pew Charitable Trust recently estimated that the total funding shortfall just for the 50 plans run at state level came to $1.3 trillion , meaning that’s how much more they owe in payouts than they have in assets. Oh, and that was in 2018, so we’re out of date.

The good news? Any Joe or Joanna Public can invest in real estate easily, without having to have any access to exclusive, overpriced, illiquid private equity real-estate funds. I’m not trying to bang any drum for Vanguard, but their Real Estate Index Fund /zigman2/quotes/202931846/composite VNQ -1.95% and International Real Estate Index Fund /zigman2/quotes/207079686/composite VNQI -1.09% are among the easy options you can buy and forget about.

Oh, and overall public REITs have been an excellent long-term investment .

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