We were flabbergasted as well as flummoxed to learn recently that New York City’s pension funds have paid billions of dollars in fees to Wall Street money managers over the past decade. Is there, perhaps, a better way for public officials to manage your retirement money?

Writing in the New Yorker, financial analyst and researcher Dan Davies digs into the numbers of the NYC pension funds. Let’s see if we can extract something useful! First, the fees:

I covered the institutional-fund-management industry as an analyst for ten years, and was never given specific information on the pricing of individual deals, but I would estimate, based on the growth of the funds from 2004 to 2014, the variance in the market (especially the crash of 2008), and the total fees, that New York City paid, on average, about 0.2 per cent, or what a fund manager would call “twenty basis points.” You would expect the trustees of such a large portfolio to strike deals on fees, and indeed twenty basis points is much lower than the average paid to managers of most actively managed mutual funds (between seventy-four and eighty basis points, according to theInvestment Companies Institute). It is still far more, though, than the five basis points charged by the Vanguard index tracker fund to large institutional investors.

So the spread between what the city was paying to its pension fund managers and the cheapest publicly available rate for buying index funds (the sort of investments that one would expect to make up the vast majority of a pension fund’s holdings) was 0.15%—representing a cost of $1.5 billion over ten years. Even for an enormous investment fund, this is a lot of money.

Let us point out here that the reason that Wall Street money managers charge more than simple index funds is primarily because they promise “outperformance,” which means that they are trying to make an investment gain greater than the gain of a broad index like the S&P 500, or of a portfolio made up of low-priced indexes of stocks and bonds. Quite a large body of research, though, shows that high-priced money managers as a group tend to be incapable of sustained outperformance once you deduct their fees. This is essentially what happened in the case of NYC’s pension funds: almost 100% of the outperformance gain was eaten up by management fees, so the only people who really benefited were Wall Street money managers. Davies touches on part of the issue here:

The bigger question is whether New York, and other places dealing with large public pension funds, ought to be paying these kinds of fees at all. The safest alternative, per the Maryland study, would be to index the pension funds at, say, five basis points. Following the presentation used by Stringer, this would mean, with close to certainty, that over a ten-year period New York City’s pension funds would pay five hundred million dollars to Wall Street and get no outperformance—a net cost of five hundred million dollars. A second possibility would be to keep the same fund managers and try to bargain down the fees, say to fifteen basis points. From 2004 to 2014, that would have meant one and a half billion dollars of fees paid for two billion dollars of outperformance, a net benefit of five hundred million dollars. But there would be no guarantee of outperformance in the future, and a considerable risk of underperformance.

Either invest in cheap index funds and give up the dream of outperformance; try to bargain down your money management fees and pray that they will be justified by outperformance in the future; or, as a third option, just hire your own set of people to manage your investments in-house, and hope that you can pay them less than you would pay outside money managers.

You’ll note that all of these options are cheaper than what New York City has been doing with its pension funds for the past decade. Only the first option, however—investing it all in low cost index funds—guarantees that your retirement money will be invested at the lowest possible cost, which is the only part of investment returns that you can actually be sure of.

More importantly: note that all of the billions of dollars that are being thrown at Wall Street are solely for the purpose of chasing the dream of outperformance. Which not only cannot be guaranteed, but which is statistically unlikely to occur, after fees. All of this skim that is being taken from your retirement money only exists for the purpose of saying, “The stock market returned 6% this year, but we will pay millions of dollars in the hope that we can get 6.5%.” I have an alternate proposal: stop chasing outperformance. Accept regular old performance! It is possible to pay very cheap rates to have your money grow at the same rate as the financial markets as a whole. Just take that growth! It’s cheap! You know it’s cheap! All the rest is gambling.

Performance can be had cheaply. Outperformance is expensive—and you probably won’t even get it after you pay for it. Instead of praying that they can scratch off the lottery ticket that holds the magical money manager who will bring in a zillion-percent return, the officials that manage public pensions should focus on realistic projections of pension returns and prudent management. Don’t fuck around with the money today and then pray to make it up on the back end with outperformance. That’s gambling addict behavior.

I only hope that this blog post about pension fund management fees does not get so popular that its “groupies” detract from the seriousness of the underlying subject.

[Photo of where your retirement money went: Flickr]