South Dakota Continues to Lead the Nation in Public Pension Returns, Without the Need for Proxy Advisors

As 2020 drew to a close, new research from the Institute for Pension Fund Integrity provided an overview of the current state of public pension funding and returns across the board. By providing a state-by-state analysis, we hoped to demonstrate just what specific factors have led to the success and failure of state funds, with the hope that policymakers and elected officials could learn by example and make better decisions in the future.

The new whitepaper draws data from the Vanguard Total Stock Market and Bond Market Indices to build two passive index investment portfolios for comparison: one portfolio was 60% stocks, 40% bonds, and one was 50% stocks and 50% bonds. Unfortunately, but not unexpectedly, most states continue to struggle. Only five out of the fifty-two pension funds that were analyzed outperformed the 60/40 passive index fund. Across the board, it seems that unfunded liabilities remain the norm, with fund managers continuing to make politicized but underperforming investment decisions rather than prioritizing returns for beneficiaries.

Although the current state of public pensions in the United States remains a disappointment, there is one bright spot that is worth highlighting. South Dakota is a shining example, with a funding ratio of over 100 percent and investment returns that are 71 basis points stronger than the 60/40 index portfolio. These promising metrics have been consistent for the past several years.

One has to wonder – what policies and efforts have led to this success, and why haven’t more states followed suit given their own financial distress? Many factors come into play. For one, the state’s investment officials have maintained a commitment to straightforward value-based investment choices consistent with their fiduciary responsibilities. South Dakota has also made an effort to retain top financial talent in the state, incentivizing up-and-coming investors to stay and help shore up their home state pensions rather than immediately going to cash out on Wall Street.

However, one key factor which stood out is that unlike many of the severely underperforming state pensions, South Dakota does not rely on advice from proxy advisory firms for its investment guidance.

As the IPFI board has written, previously, advice from proxy advisory firms is often misguided and intended to shore up their own business interests rather that serving the needs of their clients (and, ultimately, pension beneficiaries). Unlike public pension fund managers, they have no obligation to fiduciary responsibility, and limited transparency. The proxy advisory world is dominated by two firms; together, they control approximately 95% of the proxy advice market, creating an effective duopoly and undermining shareholder rights. Furthermore, through the practice of automatic voting, many proxy firm clients have effectively forgone their obligation to evaluate proposals and ceded decision making to these firms, often with detrimental results.

Fortunately, in recent months there has been an increased awareness of these inherent issues in proxy advisory decisions at the federal level, and both the SEC and U.S. Department of Labor have taken steps to implement regulatory reforms. It is now our hope that given the evidence shown through South Dakota’s tremendous success in pension management, we will see changes at the state level driven not by federal intervention but by straightforward fiscal analysis.