How to Ensure Transparency in Public Employee Pension Fund Governance

For the trustees of state and local public pension funds, who invest and manage more than $5 trillion in assets nationwide, transparent investment reporting serves as the cornerstone for making informed, accountable, and effective decisions.

In most states, trustees are fiduciaries, legally mandated to act in the best interest of plan participants. As such, they should provide pension plan members, beneficiaries, sponsors, and other supervisory authorities with clear evidence of sound processes and effective oversight of plan operations. That includes their adherence to each plan's investment policy statement (IPS), the document that lays out a fund’s objectives, guidelines, and strategies. According to the Chartered Financial Analyst Institute, board members can achieve this goal “not only by making effective strategic decisions but also by having a defensible, repeatable, and documented process as evidence of due diligence.”

The Pew Charitable Trusts has developed a model governance framework that highlights how transparent reporting supports robust oversight to meet trustees’ fiduciary duty. Components of the framework include the establishment of clear plan objectives, assessment of risk profiles, formulation of investment policies, provision of comprehensive disclosures on performance and costs, and engagement in ongoing monitoring and review processes.

The information gathered then helps to shape the future direction and content of the IPS. This foundational document includes a comprehensive framework for management of the plan's assets, detailed guidelines on the strategic allocation of plan funds, target rates of return for each asset class, and cost breakdowns by asset class and external managers.

A model governance framework

Transparent reporting then allows administrators and trustees to ensure that the plan's investments align with its objectives and long-term goals, taking into account risk and cost considerations. It also provides pension plan stakeholders with clear evidence of a board’s sound decision-making and effective oversight. When disclosures accurately and completely capture a robust “virtuous circle” of monitoring and review of investment policies and procedures, built on comprehensive reporting on performance and costs from fund managers, stakeholders have the evidence they need to affirm that the board is meeting its fiduciary duties.

Pew’s governance framework describes a structured and accountable environment for managing pension funds. It aligns decisions with the fund's objectives, manages risks, ensures transparency, engages stakeholders, and facilitates adaptability to changes, contributing to positive outcomes for beneficiaries.

Effective oversight using this governance framework enables trustees to evaluate the fund's performance, assess the effectiveness of strategies, and make necessary adjustments in response to changing circumstances. Specifically, public employee pension trustees should:

• Establish clear plan objectives. Clear objectives provide a foundation for decision-making, ensuring that pension fund activities align with its intended purpose. They help guide investment strategies, risk management, and overall decision-making processes. Trustees should define and set clear, measurable, and achievable goals and objectives for the public pension plan. This includes determining target investment returns, as well as the risk tolerance for the fund.
• Assess risk profiles. Understanding risk is crucial for aligning investment strategies with the preferences and risk tolerance of plan fiduciaries as well as the ability of plan sponsors to bear that risk. Such assessments help to strike a balance between potential returns and risks, ensuring the long-term sustainability of the fund. Trustees should evaluate the inherent risks associated with different investment strategies, whether they adhere to the risk tolerance defined by the board, and the potential impact of various risks on the fund's overall financial health.
• Formulate investment policies. A fund’s investment policies provide a framework for making consistent and informed investment decisions. They help manage risk, optimize returns, and ensure that investments align with long-term objectives and risk tolerance. Trustees should use the risk analysis to create guidelines and policies that govern investment decisions in an IPS. The document should spell out asset allocation strategies, permissible investment instruments, and risk management practices.
• Provide comprehensive disclosures on performance and costs. Effective and complete disclosures foster trust and accountability among plan participants and other stakeholders. Transparent reporting enables informed decision-making, helps manage expectations, and ensures that all parties are aware of the fund's financial health and performance. Trustees should communicate transparently with stakeholders about the performance of the fund's investments and the associated costs by disclosing investment returns, fees, and other relevant financial information.
• Engage in ongoing monitoring and review processes. Regular evaluations help ensure that a pension plan remains aligned with its objectives and adapts to evolving financial landscapes. Trustees should regularly assess the performance of the fund, review the effectiveness of investment strategies, and make adjustments as needed. This includes monitoring market conditions, investment manager performance, and overall fund health.

State actions over past decade reflect robust fiduciary monitoring and review

A number of state boards have been making decisions that reflect these kinds of deliberations, monitoring, and information gathering. In 2014, for example, the California Public Employees' Retirement System board of trustees voted to eliminate allocations to hedge funds after concluding that the investments were too complex and expensive and could not provide an effective hedge against market volatility at a sufficient scale. 

Similarly, in December 2021, the board of Pennsylvania’s Public School Employees’ Retirement System approved an update to the plan’s investment policies that would gradually divest its $6 billion in hedge fund holdings and reallocate the proceeds to lower-cost investments. Pension funds in Kentucky, New Jersey, New York City, and Rhode Island also have slashed or eliminated their allocations to hedge funds in the years following California’s decision.

In 2016, Pennsylvania lawmakers established the Public Pension Management and Asset Investment Review Commission to enhance transparency and reduce fees paid to investment managers. The commission found that the state’s two largest pension funds could save $10 billion by “pursuing more cost-efficient investment strategies, renegotiating existing fee terms, developing greater internal capacity, and eliminating operating redundancies” between the two retirement systems.

Ultimately, transparency in investment reporting equips governing boards with the information necessary to make informed and accountable decisions. And that information is vital for shaping the strategic direction of public employee pension plans and to provide evidence of trustees’ due diligence in meeting their fiduciary duties.

Susan Banta is a project director and Claire Lee is an associate with Pew’s state fiscal policy project.