Sidespin sub-blog, Gawker dot com, published this piece by Hamilton Nolan today that attempted another editorial takedown of "Wall Street" and New York City's public pension fund managers, claiming that "Wall Street" money managers are stealing from New York City and its pensioners.

In short, it stinks.

False Narrative

Mr. Nolan inserts this attempted fatality to highlight the greed of "Wall Street" investment managers:

The public's pension money has grown by billions of dollars. How much of that will benefit the employees whose money it is? None! It all goes to the fucking money managers! It's as if it never happened!

By implying that the city's pension funds' (note: NYC has five different pension funds covering different workers, so yes my apostrophe placement is correct) investments have made no money in the past decade, Mr. Nolan is confusing relative and absolute returns. The Comptroller's press release states (emphasis mine):

Wall Street managers of private asset classes such as private equity, hedge funds and real estate fell $2.6 billion short of target benchmarks after fees;

Over the same period, managers of public asset classes exceeded the benchmark slightly. However, those managers gobbled up more than 95 percent of the value added—over $2 billion—leaving almost no extra return for the Funds, which provide retirement benefits for 715,000 City workers, retirees and their beneficiaries;

The poor performance of private asset classes ($2.6 billion below benchmark), combined with the marginally better performance in public markets, has cost the City pension funds nearly $2.5 billion in lost value over the past ten years.

Nowhere does the press release mention their investment managers lost money in aggregate. In fact, NYC pension funds had $86 billion in assets under management ("AUM") at fiscal year end (June 30) 2009 compared to $160 billion at FYE2014. That's an increase of $74 billion! Based on the level of contributions and benefits paid at NYCERS, the largest of the city's five pension plans, it's clear most if not all of the asset growth came from investment returns.

What the report does say is that the money managers hired by the pension funds made money but, after fees, made less than their respective benchmarks. Using a baseball analogy, the fund managers had some hits and drove in some runs but collectively had a WAR of slightly below 2 (roughly the equivalent of an everyday player as opposed to the 0 WAR of a replacement minor leaguer). Breaking it down further, the pension funds' public equity managers (i.e., guys and gals who buy stock of publicly traded companies, bonds, etc.) had a WAR above 2 – they collected over $2 billion in fees but produced just shy of $2.1 billion of returns in excess of the benchmark, or about $40 million of net excess return according to the Comptroller. On the other hand, the pension funds' private asset managers (real estate funds, hedge funds, private equity funds) had a WAR below 2, perhaps even below 0, by generating returns that, net of fees, trailed their benchmarks by $2.6 billion.

Down with Hedge Funds! Or not

You might be tempted to say, "I knew those damn hedge fund sons of bitches were swindlers! They got money for nothing!" As of press time, it's unclear whether they also got the chicks for free, but in either case you should put down your pitchforks, or at least re-direct a few of them to the Office of the Comptroller. Public equity investments have visible benchmarks for comparison such as the S&P 500 or Dow Jones Industrial Average, and an investor has the option to hire an active manager, as NYC did, or invest the money in a low cost instrument that mirrors the performance of the benchmark, net of a very small fee. In private asset classes, the benchmark consists of the returns generated by a group of private asset managers that are tracked by third parties – for example, Cambridge Associates's private equity benchmark tracks the returns of 1,100 separate private equity firms, and there are other benchmarks for real estate, hedge funds, and other private asset classes. If you want to invest in private asset classes, the only option short of doing it yourself, which most US pension funds aren't equipped to do, is to hire a fund manager! NYC happened to back the wrong horses, and Mr. Nolan incorrectly equates these managers' underperformance to theft. Had the city merely hired "average" private fund managers, the pension funds would be better off by about $40 million (the amount of outperformance generated by its public asset managers) rather than be worse off by $2.5 billion. NYC is the baseball GM who willingly employed the 2013 Jeff Francoeur of private asset managers, and Mr. Nolan is arguing he should give his salary back. Shame on NYC for taking ten years to figure out that Jeff Francoeur stinks.


Is $2.5 billion a lot of money? You bet it is. But how big is $2.5 billion in relation to the city's pension funds and pensioners at large? The city's five pension funds have total AUM of $160 billion, meaning the $2.5 billion of opportunity cost represents only 1.56% of AUM, or 1.56 pennies for every $1 held by the pension funds. Furthermore, the $2.5 billion of opportunity cost was incurred over an entire decade, not just one year, meaning the annual cost averaged about $250 million, or 0.156% of current assets and still only 0.29% of assets in 2009. For comparison's sake, Vanguard's S&P 500 ETF has an annual expense ratio of 0.05% (or 0.17% if you can only muster an investment between $3,000 and $9,999).


But what do all these billions mean to the hardworking pensioners of New York City? Again, context is key. According to the press release, the pension funds provide benefits to 715,000 workers, retirees, and their beneficiaries. Dividing $2.5 billion by 715,000 workers comes out to a shade under $3,500 per person. That's a lot of money! I could certainly use another $3,500. But again, spreading the cost out over the 10 years comes out to $350 per year per worker, or less than $1 per day.


There are a lot of things wrong with the NYC pension funds – huge unfunded liabilities, poor actuarial assumptions, an incompetent staff who failed to understand gross versus net returns, multiple pension funds each with their own boards and staff, etc., and there are plenty of legitimate gripes about hedge funds and other private investments, but it's irresponsible to say "Wall Street" fund managers are "robbing [the pensions] blind" because the funds chosen by the city happened to underperform their peers. It would be great if the pension fund had another $2.5 billion, but it's just not a huge number in relation to a $160 billion portfolio that grew by over $20 billion just last year. The Comptroller's report is an attempt to shift blame away from the office's investment staff and due diligence process towards the "Wall Street" boogeymen and Gawker dot com is happy to oblige, not because it's true, but because it fits within the site's populist editorial stance.


UPDATE (4/10/15 10:10a PT): You can read the Comptroller's report here. It turns out I was wrong about the private asset benchmarks - NYC uses what's called a Public Market Equivalent ("PME") benchmark, which attempts to compare the returns generated by investing in a private asset class on a certain date with buying an equivalent amount in a public stock index on the same date. Per Dan Primack of Fortune's Term Sheet, NYC benchmarks their private asset classes against a Russell 3000 PME plus 3%. So, if the Russell 3000 returns 12%, the PME benchmark is 15%, meaning the private assets must return 15% or more in order to have exceeded the benchmark. On page 7 of the report, you can see the relative performance of the City's managers. For example, private equity funds returned roughly 9.6% per year*, compared to the PME benchmark of 13.1% (underlying index return of 10.1% plus 3%). The pension funds' private asset managers made money but not enough to justify their fees based on the benchmarks used. NYC would have been better off by not hiring these specific managers and either investing the money in low cost public stock funds or hiring better private asset managers.

*It's an Internal Rate of Return calculation rather than a time-weighted return, but your eyes will glaze over if I try to explain the difference.