Swedroe: When Board Members Hurt Returns

Elected board members and state officials don’t help your pension fund’s performance.

Reviewed by: Larry Swedroe
Edited by: Larry Swedroe

The investment policies of state and local government pension systems have shifted markedly in recent years toward alternative investment classes, such as private equity, real estate and venture capital. For example, as of January 2016, the California Public Employees’ Retirement System (or CalPERS) had almost 20% of its $276 billion portfolio invested in these asset classes, compared with just 13% in 2001.

This shift raises the stakes in understanding how governance structures can impact the creation and preservation of value for pension systems, their sponsoring governments and the employee beneficiaries.

And the stakes are indeed high. Public pension systems in the United States had $3.8 trillion in assets at the end of 2014. Raising the stakes even higher, a recent study by Aleksandar Andonov, Rob Bauer and Martijn Cremers found that pension funds governed by boards heavily populated with state officials invest more in risky asset classes (such as equity and alternatives).

This behavior—of investing in riskier assets—is likely driven by the need to present a better funding position (riskier assets have higher expected returns, improving the funding ratio).

Pension Fund Boards And Private Equity

Andonov, Yael Hochberg and Joshua Rauh further contribute to the literature with their March 2016 study, “Pension Fund Board Composition and Investment Performance: Evidence from Private Equity.” The authors examined whether some governance structures in U.S. public pension systems are more consistent than others with value maximization by focusing on the performance in pension funds’ private equity portfolios.

They note: “There are generally three types of individuals who sit on public pension fund boards. First, there are government officials, who may sit on the board by virtue of their office (ex officio) or are appointed by other government officials. Second, there are members of the pension systems themselves, who may be elected by participants or appointed as trustees. Third, there are members of the general public. Statutes and charters of pension systems, many of them instituted decades ago, dictate the relative representation of these different categories on each pension fund board.”

The authors’ sample contained 13,328 investments by 210 unique public pension fund LPs who invested in 3,919 private equity (PE) funds managed by 1,415 GPs. The public pension funds in their sample have an average of $44 billion in assets under management, and an average of 9.3 board members. Trustees representing plan participants are present on the board in 197 out of the 210 public pension funds and hold, on average, 40% of the board positions. General public board members hold, on average, 26% of the pension fund board seats, and almost all of them are appointed.

It’s also interesting to point out that of the 847 unique trustees in the subsample, only 23% have experience in asset management (and even just 48% of the public appointees have such experience). What’s more, just 2% hold the chartered financial analyst designation.

Research Findings

Following is a summary of the study’s findings:


  • The performance of public pension funds’ PE investments is strongly related to the relative representation of the different member categories on their boards.
  • Each additional 10 percentage points of board membership that goes to government officials reduces performance by 0.9 net internal rate of return (IRR) percentage points if the official is appointed by another government official, and by 0.5 net IRR percentage points if the official sits on the board by virtue of his or her office (ex officio).
  • An additional 10 percentage points of board membership going to elected members of the pension plan itself reduces performance by 0.2 to 0.4 net IRR percentage points.
  • Appointed members of the general public don’t perform better than appointed members of the plan itself.
  • The results are mirrored in analysis of cash-on-cash multiples as a performance measure, are observed in all investment categories examined, and are the strongest within venture capital (VC) and real estate.
  • The more state government officials and elected plan participants a board has, the more the fund invests in real estate and fund of funds (conditional on board and LP size). However, controlling for these asset classes only attenuates the results by about 20-30%.
  • The share of state government officials and of elected participants on a board is strongly correlated with several known proxies for poor investment selection in PE: the extent to which the LP has a bias toward in-state investments, the number of other investors a fund has besides the public pension LP itself, and the fund’s sequence number. (Funds are numbered in sequential order, with fund “I” representing the manager’s first fund, fund “II” representing its second, and so forth. Funds with higher sequence numbers indicate a longer history of performance for the fund managers and, because managers whose initial funds underperform are unlikely to be able to raise further funds in the sequence, higher sequence funds generally indicate higher-quality PE managers.)
  • State-appointed, state ex officio and participant-elected trustees underperform within both real estate and private equity. The underperformance in private equity cannot be explained solely by higher allocation to fund of funds, and it is strongly concentrated in VC funds.
  • Even within the real estate category, pension funds governed by boards heavily populated with state-appointed, state ex officio and participant-elected trustees select worse funds. An increase of 10 percentage points in a fund’s proportion of state-appointed board members is associated with a decrease of 0.80 percentage points in annual net IRR on real estate investments.
  • Boards more heavily populated by the weaker-performing categories of board-member types invest substantially more in smaller funds of earlier sequence numbers (e.g., first-time funds), which attract capital from fewer LP investors. These proxies for poor PE selection decisions explain an additional 20-30% of the underperformance by board members who are state government officials or elected participants.

The authors hypothesized that the variation in risk-adjusted investment performance might be driven by two conflicting factors. Boards with trustees that have more financial skill or investment experience might be expected to outperform the boards with trustees who possess less knowledge or less experience.

However, boards whose members face conflicts of interest might not allocate assets to maximize financial return for a given level of risk, and instead may behave opportunistically due to personal career and political contribution considerations. These include behaviors such as favoring local ventures in their allocations and overweighting companies that contribute funds to their political parties or otherwise lending support to their personal career prospects.


Beware In-State Investments
In this context, it’s important to note that research has found that in-state investments of public pension funds achieve lower performance than the performance of their own similar out-of-state investments. The authors also observed that plan participants are expected to have the least financial experience. Their findings support their hypotheses; for example:

  • The lesser financial expertise of plan members elected to the board can explain most or all of their underperformance. However, it doesn’t explain the lower returns of state-appointed and state ex officio trustees who, on average, score moderately well on financial expertise but display the largest underperformance of the groups in the sample.
  • Political contributions matter and explain part, but not all, of the negative performance effect that government officials seem to have on public pension boards, indicating that at least some of the underperformance of elected officials relates to political incentives.
  • Public pension funds governed by state-appointed, state ex officio and participant-elected board members invest more in PE funds shunned by other public pension funds and local institutional investors.
  • Underperformance is especially large among local, in-state real estate investments.
  • Local investments in VC funds also deliver lower returns.
  • For an additional $100,000 of financial contributions, a $10 billion pension fund would have worse performance by 0.27 net IRR percentage points. Adding prior professional experience controls does not materially attenuate the result.
  • Pension funds managed by trustees who have received relatively more contributions from the financial industry tend to have lower returns. A vast majority of trustees who receive political contributions are state board members, and controlling for political contributions explains part of their underperformance.

The authors also noted that there’s a great deal of stability in fund structures, particularly for the largest funds, and that regulations pertaining to the board composition of most plans were adopted long ago, well before PE became a significant part of plan allocations.

They identified only 36 instances of changes to board structure during the sample period, and some were very minor in nature. The findings in this and other studies on the subject clearly demonstrate that governance rules should be updated.


The findings in this study show that reforms are needed. It’s critical that a strong governance structure be put in place—one that accounts for the skills and incentives of the board members. The study demonstrates that taxpayers and pensioners alike are negatively impacted by poor governance structures that allow political contributions and career incentives to negatively impact the performance of public pension plans.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.


Larry Swedroe is a principal and the director of research for Buckingham Strategic Wealth, an independent member of the BAM Alliance. Previously, he was vice chairman of Prudential Home Mortgage.