A piece of research from an obscure think tank made a bit of a stir in the pension world in July. Both The Wall Street Journal and the Financial Times took note of a study by Jeff Hooke and John J. Walters published jointly by the Maryland Public Policy Institute and the Maryland Tax Education Foundation. Mr. Hooke argues that public pensions are paying too much in fees to their external investment managers, and getting too little performance in return.  And, he also has a plan to fix it.

Looking at pensions in 46 states for the fiscal year ending in June, 2012, the study found total management fees were $9 billion.  The authors suggest that this outlay could be cut by two-thirds, or $6 billion if pensions simply put most of their assets into low-cost index funds.  This move would allegedly not only cut expenses, but increase net returns.

They report that the funds paying the highest fees saw a median 5-year net return of 1.34 percent; while the funds paying the lowest fees returned 2.38 percent; which, on its face, doe seem a bit perverse.

Coincidentally, at about the same time, a small public pension in Montgomery County, Maryland (a Philadelphia suburb) chose to do exactly what Mr. Hooke advised.  They moved most of their $470 million into index funds under the Vanguard Group.

The chair of the Montgomery County Board of Commissioners told the Wall Street Journal that: “The folks on Wall Street do valuable work.  But there is no value for the county and other municipalities to be spending these fees and getting a lower return.”

Vanguard headquarters is in Malvern, PA, just a few miles from Philly, and the County had already been doing some business with them.  One day the county’s board chair and CFO dropped into John Bogle’s office on the Vanguard campus and sealed the deal.  We admire Mr. Bogle, Vanguard’s semi-retired founder, and we are gratified to see that, at age 84, the man still knows how to close a sale.

Some of our sophisticated readers are rolling their eyes.  There is a strong argument, for instance, that a pure index-fund strategy buys too much volatility.  Alternatives, when they work, are supposed to non-correlate with the major indexes to help insulate portfolios from the ebbs and surges of public markets.  And alternatives are still not readily available in liquid, ETF form.  So, asset-owners have to pay up to get active management of alternatives.  But, the unsophisticated might still reply: volatility-reduction is good, but only if you can get it at a reasonable cost.

The Hooke study has continued to ricochet around the country, attracting both interest and brickbats.  It fingered the South Carolina pension fund as having the highest fee ratio: 1.3 percent on beginning-of-the-year assets in fiscal 2012, versus a median ratio of 0.39 percent.  Officials at the South Carolina Retirement System Investment Commission were, predictably, not amused, and responded that their fees are reasonable for their specific (alternatives-heavy) portfolio.

We’ve grappled with the fees in South Carolina previously.  Readers may recall that we interviewed state treasurer Curtis Loftis, back in May, 2012, on the same topic.  Mr. Loftis has long inveighed against those fees and says that they are not justified by the fund’s modest returns.

We don’t want to delve too deeply into this murky subject, but we think there are two points worth mentioning:

First, the South Carolina people make a reasonable point: if investment managers, in their wisdom, choose an unusually high allocation to actively-managed alternatives, they are going to pay higher fees relative to their total assets.  There’s nothing necessarily improper or scandalous about that.  The SC pension allocates about twice as much to alternatives as the typical state pension and, over time, that allocation will either justify itself, or not.

Second, the SC people, and others, have complained that the study is flawed because public pensions around the country don’t report their expenses in a uniform way, which unfairly disadvantages some when those ratios are calculated.  Here, we’re inclined to defend Mr. Hooke and his co-author John J.  Walters.  We’ve read the paper and talked to Mr. Hooke.  We’ve also spent some time ourselves trying to wring information out of the public reports of various pensions, a task we wish on no one.  We think they did a conscientious job in extracting data from public reports, which is harder than it looks.

Every state pension publishes a CAFR – comprehensive annual financial report – which is supposed to follow rules of the Government Accounting Standards Board.  But there is a certain amount of wiggle room regarding reporting investment expenses.  Sarah Niegsch Corbett, director of the SC pension’s operational due diligence, told The State newspaper that accounting rules for reporting investment fees are not very specific and that “a lot is left to interpretation.”  She says that they disclose more than they are strictly required to.  The South Carolinians point to Florida, which says in its own reporting that carry and performance fees for real estate, infrastructure, hedge funds, private equity and overlays are not included in their dollar amount for “fees.”

Pensions use consultants who figure out what expenses they’re really paying and how they compare with their peers.  CEM Benchmarking up in Canada, for instance, is a specialist in this area.  But, of course, this information is confidential.  They may allude to the existence of such studies to suggest that they are, in fact, really cost efficient.  But the public has to rely on the numbers actually presented by the accountants, which vary from state to state.  So we sympathize with Mr. Hooke when he tries to interpret public documents and is told that the data in those documents are flawed and inconsistent, by the same people who publish the documents.

When I called up Mr. Hooke he was happy to talk to me about his study.  Well, maybe “happy” isn’t quite the mot juste.

Jeff Hooke, incidentally, has a solid bio: BS from Penn, MBA from Wharton, and work at places like Lehman Brothers and International Finance Corp (a World Bank affiliate).  And, as an investment banker, he understands the fee-earning side of the business.

His research into public pension fees has been done completely gratis, on his own time and his own dime (the Maryland Tax Education Foundation is mostly just him) and he told me that that he’s through tilting at this particular windmill for now.  He made himself available to various legislative committees, but he got the impression that sharply reducing pension costs was not high on any political wish-lists.  One brave person took him aside and told him that they might think about moving some assets into index funds, as long as CalPERS does it first.And, some of the people he does business with in his investment-banking capacity weren’t necessarily slapping him on the back for his public-spiritednes, either.

But we congratulate him for his honorable effort.

Charles A. Skorina & Co is retained by the boards of institutional investors and asset managers to recruit chief investment officers, portfolio managers, and financial professionals.

Charles Skorina earned an MBA at the University of Chicago and began his professional career at Chemical Bank (now JPMorgan Chase), completing the management training program then working as a credit and risk analyst in New York and Chicago.  After a stint with Ernst & Young in Washington, D.C., he founded his own search firm headquartered in San Francisco, focused on the global financial services industry.