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Why 1 Kentucky State Pension is Outperforming the Other

It was the best of pensions, it was the worst of pensions.In 2013, the $14.5 billion Kentucky Retirement Systems' investment portfolio drastically underperformed its cousin—the Kentucky Teachers Retirement System—by about $1 billion.Moreover, last year the KRS underperformed the average public pension's investment plan by about $500 million.What's the difference?The takeaway is that Kentucky is home to one of the best-performing public pensions, and, in the case of KRS, one of the worst,  according to Chris Tobe, a former trustee to the Kentucky Retirement Systems turned whistleblower, author and go-to investment gadfly for muckraking financial journalists.In 2013, KRS reported a 12.7 percent return on its investment portfolio. KTRS, meanwhile, earned 19.7 percent, well above the national average of 16 percent on returns and placing it within the top 4 percent of pensions nationwide with assets over $1 billion.The difference between the two works out to about $1 billion.The implications of such underperformance in a state public pension have a wide effect on the state's fiscal health, from higher construction fees on bonded public construction projects to draconian pension "reforms" that place a higher burden on public employees. And it threatens the stability of other pensions connected to it.It can also affect the ability of the pension itself to pay benefits, as about 68 percent of KRS's benefit payments are directly derived from investments.The shortfall in investment returns dwarfs the $100 million appropriated this year by the Kentucky General Assembly to shore up the perpetually underfunded KRS pension. Meanwhile, lawmakers did not allot the $1.4 billion requested by the KTRS to shore up its underfunded system, whose total liability to taxpayers will grow from its current rate of $14 billion in unfunded liability to $23 billion when new federal accounting practices are adopted next year.Tobe says that a penchant for high-risk, high-fee private hedge fund investment and a lack of oversight and financial disclosure greatly contributed to KRS's poor performance last year. Conversely, KTRS invested in less risky, more stable securities, and posted stronger returns.Throughout its lifetime, the KRS has posted an average of 9.5 percent on its returns. The negative implications of political interference into public pensions have been outlined in the pages of Rolling Stone and, more recently, a Pando article by journalist David Sirota, who took aim at KRS's nearly $60 million high-risk investment into the private equity fund Blackstone Capital Managers V.

[Tobe] points out that according to KRS financial statements, Kentucky invests an above- average 34 percent of its assets in “alternatives.” That strategy last year delivered roughly  12 percent returns for KRS – far below the 16 percent median for public pensions. The high fees involved in such “alternatives” may help explain, in part, why a December 2013 KRS presentation (embedded below) shows the pension system is now just 23 percent funded – a rate that Tobe says is one of the worst in America. That said, another reason why pension funds have moved into risky high-fee investments may have to do with political influence and campaign cash from the Wall Street firms that stand to benefit from the alternative investment craze.

"[KTRS] did just basic stocks and bonds, and a little bit of alternatives," Tobe says. "And KRS—and they're not the only one in the country—but there's like 20 percent of them that just loaded up on all these crazy hedge funds and private and private equity funds."Tobe says that the KRS fund underperformed so badly last year, it would have to outperform the market for the next five years just to recoup its losses from 2013.KRS also paid out about $50 million in investor fees in 2013. Those fees go to money managers. That same year, KTRS paid less than half that amount, $23 million, in such fees. KRS, therefore, "is paying twice as much in fees for a lower return," Tobe says. "That's one way to look at it."