In a lengthy interview in yesterday’s Journal, David Swensen, the longtime chief investment officer for Yale’s endowment, had an implicit warning for public pension funds and other supposedly “sophisticated” investors (ha ha) whose overseers think that they can beat the market with “alternative” investments in things like private equity, real estate, and derivatives. While it may seem like closing the barn door after the horse has escaped, trampled the cat, and been run over by an 18-wheeler, Swensen’s words are still important for public-money stewards who may be tempted in upcoming years to become even more creative in their investments to make up for the last year’s losses.

Says Swenson of pension funds and other institutional investors whose managers “think they are emulating Yale” in delving into asset classes beyond stocks and bonds, “they are not.” Unlike Yale, “[m]ost endowments use … consultants, rather than making their own well-informed decisions. You can divide institutional investors into two camps: those who can hire high-quality, active-management investors and those who can’t.”

Swensen excoriates this consultancy world, as well as “funds of funds,” which arewere hedge funds whose claim to fame was that they picked a portfolio of other hedge funds in which to invest. “If an investor can’t make an intelligent decision about picking managers, how can he make an intelligent decision about picking a fund-of-funds manager who will be selecting hedge funds?” Swensen asks sensibly. As for the consultants, they “make money by giving advice to as many people as possible. But you outperform by finding inefficiencies most of the market has not yet uncovered.”

Swenson concludes that he doesn’t think an institutional fund, including a pension fund, can be successful in employing a sophisticated investment strategy unless it employs in house “20 to 25 investment professionals who devote their careers to looking for investment opoprtunities. … If you’re not going to put together a team that can make high-quality decisions, your best alternative is passive investing,” meaning stock and bond index funds and the like.

The techniques that Swensen rightly excoriates are exactly how big public pension funds have executed their own “alternative” investment strategies (although New York State absolutely does deserve some credit for having stayed far away from Bernie Madoff). That is, the public funds have employed consultants, often politically connected ones, and they’ve hired outside managers to do the investment work.

But, as Swensen points up, those outside managers are only as good as the internal managers — in the case of public-pension funds, ultimately the elected officials — who choose them.

Indeed, Swensen doesn’t go far enough here. Even the supposedly best and brightest of internal managers in the private investment world with far superior, earlier information than the information that public pension funds ever got made disastrous choices over the past decade.

In the case of the public funds, then, it’s fair to say that it’s a random process marred by politics.

In light of this grim analysis, Swensen’s suggestion — that institutional investors whose overseers can’t or won’t do their own tough analysis stick to passive investing — is worth thinking about for the public pension funds.

Would elected officials ever direct public funds to even consider analyzing the benefits and costs of such a switch?

If they do, one thing they’ll surely consider, at least in private: Passive investment just doesn’t create the same opportunity for public-sector pension-fund managers to dole out patronage-laden fees (and get campaign contributions and post-public-sector job opportunities in returncoincidentally).

And a passive investment strategy would make it more difficult for public-fund managers and elected officials to convince themselves that they could cut volatility in investment returns.

This delusion has been immensely valuable to elected officials, because it has enabled them to award ever-higher benefits to public-sector workers during the good times.

You may also like

New York’s Hospital Industry Ranks Near the Bottom of Two Quality Report Cards

New York's hospitals remain near the bottom of two quality report cards. The state's hospitals received the lowest rate of any state except Nevada and DC. Read More

As a Supreme Court Ruling Loomed, Cuomo Bent His Own Rules on COVID ‘Clusters’

In the midst of the constitutional showdown over his pandemic policies, Governor Cuomo made changes to a disputed Brooklyn 'cluster zone' that seemed to contradict his own declared guidelines. Read More

New York Has Widened Its Lead in Per-Capita Spending on Medicaid

New York's per-capita Medicaid spending soared to more than double the nationwide rate in 2018, widening its gap with the other 49 states. Read More

Essential Plan surplus hits $3B

As Governor Cuomo pleads for financial help from Washington, one of his state's programs is sitting on $3 billion in unspent federal aid: the Essential Plan. Read More

Upstate escapes the worst

With the coronavirus pandemic hitting some parts of New York much harder than others, Governor Cuomo has signaled that he will begin to relax shutdown restrictions in low-virus parts of the state. Here's a closer look at how infection and fatality rates vary from region to region. Read More

NY is shorted on virus relief

Although New York is taking the brunt of the coronavirus pandemic – with 43 percent of the nation's known cases and 40 percent of the deaths – the state is due to receive only 5 percent of the $150 billion Coronavirus Relief Fund just established by Congress. Read More

NY’s uninsured rate hits new low

Bucking the national trend, New York's uninsured rate dropped for the eighth consecutive year, new data from the Census Bureau show. The share of New Yorkers lacking health coverage in 2018 was 5.4 percent in 2018, down from 5.7 percent the year before. The number of people lacking health coverage dropped by about 72,000, to just over 1 million. Both the rate and the number are roughly half what they were in 2013, the year before the Affordable Care Act went into effect. Read More

SOTS health-care roundup

Health care was the dog that did not bark at Governor Cuomo's combined State of State and budget address on Tuesday. Instead of announcing a major plan to expand coverage, he called for appointing a commission to study "options for achieving universal access" and report back by December – a clear sign that he has no stomach for tackling the issue in this session. Read More