How Benchmarks Keep Pension Stakeholders in the Dark

The self-constructed yardsticks used by U.S. public pensions are often conflicted, “acting as player as well as scorekeeper,” according to new research from Richard Ennis.

Illustration by II

Illustration by II

There’s no shortage of studies arguing that pension funds and endowments would have been wise to put the kibosh on their complex portfolios and opt for a simple passive strategy over the last five, 10, or 20 years.

But new research from Richard Ennis, one of the founders of investment consultant EnnisKnupp, details another fault line in the argument.

Benchmarks in investing, just as in sports or healthcare, are designed to measure performance, costs, risk, and other data points against peers or alternative approaches. The idea is to inject objectivity into the process. Ennis argues, however, that benchmarks in the public pension world do more to obscure the nature of portfolios than shine a light on what they could do better.

Benchmarks “are devised by the funds’ staff and consultants, the same parties that are responsible for recommending investment strategy, selecting managers, and implementing the investment program. In other words, the benchmarkers have conflicting interests, acting as player as well as scorekeeper,” wrote Ennis in his study published this week. Ennis, who said he’s no longer speaking publicly about the issues he’s researching, added in the study that public pension funds describe their benchmarks as “policy,” “custom,” “strategic,” or “composite,” but the end result is a measurement tool that is complex and hard for external parties to replicate.

In the report, called “Benchmark Bias of Public Pension Funds in the United States: An Unflattering Portrait,” Ennis used publicly available data to study the annual returns of 24 U.S. public pension funds from July 1, 2010 to June 30, 2020. He found that the 24 underperformed a passive strategy by an average of 1.4 percent a year. Over the same time period, the funds reported that they beat their own custom benchmarks by an average of 0.3 percent a year.

“Examination of the differences raises questions about the integrity of performance benchmarking as practiced by public pension funds in the United States,” wrote Ennis. After examining data on the largest U.S. public pension funds, Ennis believed only 24 had comprehensive enough information from which to draw robust conclusions.


He also analyzed each fund’s Sharpe ratio, or risk per unit of return, and compared returns to a passive benchmark based on an approach devised by William Sharpe. He included non-overlapping market indexes, including the Russell 3000 stock index, the MSCI ACWI ex-U.S. stock index, and the Bloomberg Barclays US Aggregate bond index.

Ennis estimated that the investments costs for the pension funds in the study averaged 1.3 percent, based on multiple studies, including ones from the Pew Charitable Trust and CEM Benchmarking.

“The vast majority of the funds underperformed passive investment over a recent 10-year period,” he wrote. “The average margin of underperformance is -1.41 percent a year. The margin of underperformance is in line with my estimate of the cost of investing large public pension funds, which is 1.3 percent a year.”

Ennis admitted that the study has flaws, including using the relatively short 10-year time frame, studying only half of the largest U.S. state pension plans, and using reported returns that have not been independently verified.

Still, Ennis argued that his study shows that billions are being wasted.

“If, in fact, $4.5 trillion of public pension fund assets are underperforming by 1.4 percent annually, it would amount to an outright waste of $63 billion a year, moneys that could well be applied to the payment of benefits or the reduction of taxes,” he wrote.