Opinion: ‘Get Shorty’ meets the statehouse in a $1.5 trillion pension caper

“More than 33% of public pension assets have been committed to private equity, hedge funds, real estate, and other alternatives—as opposed to public equities or fixed income—since 2015, and the share is only growing,” reports Equable. “Pension fund asset allocations continue to expand into private equity and other alternatives. The value of investments in alternative asset classes has grown from around $100 billion in 2001 to over $1.6 trillion in 2022.”

Some of the money comes from pension contributions paid every two weeks by teachers, firefighters, cops and other state and local employees. Some comes from state and local taxes, including from property taxes and income taxes that fall heavily on the middle class, and from state sales taxes that are felt most heavily by the poor. And some come from federal tax dollars, which are spent in multiple ways supporting states, cities and towns.

Meanwhile, as the money goes into these high-fee alternative funds, the managers don’t just get rich on the fees: They also benefit from the extraordinary “carried interest” tax loophole, that allows them to defer the tax on most of their income for years, and then to pay the taxes at low, discounted rates.

Attempts to end the loophole, initially championed by Donald Trump as well as many others, have miraculously failed on Capitol Hill. It is of course pure coincidence that hedge-fund managers, private-equity managers and venture capital managers are often very generous campaign donors.

You could call it something worthy of an Elmore Leonard novel.

You could call it Robin Hood in reverse.

Or you could just call it business as usual. 

As a famous study showed last decade, U.S. government responds to the wants and needs of the donor class, not the rest of us.

The rationale for funneling all these tax dollars to high fee investment funds is that those managing America’s state and local pension funds are trying to dig themselves out of a $1.5 trillion hole.

That’s the size of the unfunded liabilities in the pensions’ accounts, Equable now calculates.

Already, the cost of paying for these liabilities is becoming painful for governments. Employers’ contributions to the pension funds—meaning, ultimately, taxpayers’ contributions—have just topped 30% of payroll for the first time ever, according to the Equable analysis. And about two-thirds of that money goes to make up for unfunded liability payments. Between 2001 and 2022, the payments going to meet unfunded liabilities have risen more than 2,000%. 

Pension trustees are hoping these “alternative” investment funds will somehow bail them out by providing higher returns. They have become “addicted to risk,” as Equable puts it.

Whether this will even work is up for debate. Funds fell well short of their targets during the last fiscal year, earning an average of 5.3%, Equable reports. Despite the marketing hype, private-equity funds overall are no longer producing the spectacular returns of yesteryear—at least, not for the investors. Hedge funds infamously underperform the public markets as a group, as Warren Buffett has shown. The numbers on these funds are not in the investor’s favor.

Meanwhile private-equity funds, who must squeeze every nickel of profit out of their investments to pay for their fees (as well as any returns), end up doing stuff like stripping too many nursing staff from nursing homes, sometimes resulting in “higher patient mortality.”

The main winners from these funds, of course, are those managing them. Which is what you’d expect. If a hedge-fund manager knew how to beat the market, why would they cut any outsiders in at all? Renaissance Capital, arguably the only such fund, dumped outside investors for precisely this reason.

As Groucho Marx might have said: You’d never want to invest in any hedge fund that would take your money.

So, just to recap: Tax money comes from you. It goes to very rich people who have a special tax exemption for which you are not eligible. And if their funds don’t perform miracles, which they won’t, who has to make up the difference? You got it.