Is bigger better?

Illinois and Louisiana each is considering merging their public employee retirement systems into a single system within each state.

Consolidation appears to be a good idea, resulting in reduced investment fees and staff, while potentially improving investment returns with bigger portfolios.

The effort is close to reality in Indiana. The Indiana Senate on April 14 overwhelmingly passed a bill to merge the boards and administration of the state systems, following the Feb. 23 passage of an earlier version of the bill by the House. The versions have to be reconciled before the bill can go to the governor for his signature.

Pooling the assets of the $11.4 billion Indiana Public Employees' Retirement Fund and $6.8 billion Indiana State Teachers' Retirement would generate a 0.2 percentage point increase in annual investment returns, equivalent to $60.5 million, according to a fiscal impact statement of the Legislative Services Agency's Office of Fiscal and Management Analysis. The pooling would also reduce investment fees and administrative cost, an estimated $8.9 million one-time administrative cost saving and $1.2 million annual recurring administrative cost saving, the statement said. It didn't provide a breakout of investment cost reduction.

Consolidation also would build influence as larger asset bases would attract top-tier, highly sought-after managers of hedge funds, private equity funds and other alternative strategies.

Mergers also could give the new larger systems more leverage to deal with legislatures on issues of plan funding and staff compensation. Better compensation could attract better professional staff. Better budgets for consulting and investment fees also might help improve performance.

But the state legislatures should consider a number of issues before making a decision to merge the systems.

For example, a combined system a bigger system doesn't necessarily create a system free of investment management problems or greater sophistication to deal with increasingly complex investment issues. Even economies of scale have diminishing returns and limits.

Right now, for instance, many systems face impairment of collateral in their securities lending programs as a result of the credit-market freeze and what appears to be overly aggressive investment to boost income. Larger systems were no less immune to the difficulty than smaller systems.

Legislatures don't necessarily grant more latitude to run investment management programs to large funds than to small funds. Up until 2007, the Iowa Legislature imposed a 40-basis-point cap on investment management fees and expenses. Although that cap had not prevented the system from hiring any manager, the system successfully sought removal of the ceiling, concerned it could be an impediment to hiring managers of alternative investment strategies.

Combining retirement systems would result in a single board of trustees, rather than multiple boards. But would trustees, already often challenged in dealing with sophisticated and complex investment strategies, serve any better in a larger system? They would still come from the same pool of candidates and have to deal with the more complex issues posed by a larger system.

For smaller public pension plans, however, such as those of countless municipalities across the country, consolidation could provide them the more sophisticated investment management they could never otherwise afford.

Consolidation doesn't make sense unless the state is ready to step up trustee education requirements and pay for such programs, to exercise greater oversight of pension fund management and to provide more transparency to the public. The Indiana legislation requires at least 12 hours of trustee education annually. Too often, legislative oversight tends to micromanage investment policy such as prohibiting investments in certain countries or seeking greater in-state investment or use of in-state investment services companies geared more to winning favors from certain political constituents than achieving the goal of better pension management and better funding.

Bigger systems aren't necessarily more transparent than smaller systems. Legislatures that promise better oversight and transparency with bigger funds ought to ask why the legislatures have not been able to achieve those objectives with smaller funds under their oversight.

Without legislative commitments on such issues as these, any hoped-for savings and enhanced investment performance could prove as illusory as countless other promises by politicians.