Will Gov. Shapiro do to Pennsylvania’s pension billions what he did in Montco?

When Pennsylvania Gov.-elect Josh Shapiro was serving as a Montgomery County commissioner, he led a radical redo of the half-billion-dollar county retirees pension plan in 2013.

He dumped dozens of specialized Wall Street firms — and local money managers such as Ira Lubert, Jim Nevels, and Richard Ireland — and sent most of the cash to low-fee index-fund giant Vanguard Group, plus a slice to another automated manager, SEI Investments.

As governor, will Shapiro attempt similar streamlining on the state’s far larger retirement treasure?

You didn’t hear much about the issue during this fall’s governor race. But governors have muscle — and board votes — in overseeing and funding more than $100 billion that the state worker and public school pension plans invest in stocks, bonds, private equity, real estate, and other ventures around the globe.

Despite having piled up so much cash, the plans remain one of the state’s major expenses: State and local taxpayer contribute over $8 billion to the two plans every year to keep it solvent (and more to hundreds of local-worker and police plans).

Pennsylvania’s plans are more expensive than other states, without delivering proportionately bigger benefits. Why?

Can a governor fix any of that?

Faced with multibillion-dollar gaps between what the plans own and what they owe, lawmakers, most recently under Gov. Tom Wolf, have limited pension guarantees for new hires and tried to compensate for past underfunding with the current high “contributions.” They have mostly left the selection of investments to the plans’ unpaid trustees and a web of outside consultants, who continue to oversee complex portfolios.

Could Shapiro push for bigger changes? The governor has leverage at the state pension system, SERS, because he appoints six of its 11 trustees. (The others are elected officials, some from the governor’s party.)

Governors have less influence at the larger PSERS pension system, where costs are split between the state and local school districts. The governor appoints just three of the 15 trustees for the Public School Employees’ Retirement System. That board is typically dominated by suburban and upstate PSEA teachers’ union local leaders, who currently hold five seats, and their allies, including legislators who receive teachers’ union political contributions.

The union members have reliably favored the old strategy of private investments, even when challenged by governors’ reps and the last couple of state treasurers.

How did Shapiro’s pension changes actually work out for Montgomery County? Through year-end 2021, the county had done as well as or better than the state plans since it fired Wall Street and hired Vanguard.

But simple comparisons can be treacherous, as people whose results look bad are fond of reminding us.

When the U.S. stock and bond markets sank earlier this year, Montgomery County’s now $650 million retirement plan slipped 13% for the six months ending June 30, dragging down its average returns for the past one-, three- and five-year periods below its long-term targets.

By comparison, SERS was down 5% for the first half of the year, while still meeting longer-term targets. And PSERS was one of the few plans that actually reported a small gain for the year ended June 30, while also beating multiyear targets.

These numbers don’t tell the whole story: In down markets, private investments are revalued more slowly than publicly traded stocks and bonds. Since PSERS invested more heavily in private assets than other plans, it gets the benefit of lagged reporting while stocks and bonds fall.

But that works both ways: As PSERS staff have warned trustees, private-asset devaluations could reduce results in future quarters. Indeed, on Monday, SERS reported that for the third quarter, its private equity investments dragged down the plan’s performance and did worse than U.S. stocks, which lost less than the plan as a whole.

Costs and benefits aren’t the only reasons pension reformers use to argue against a lot of private investments and for low-fee replacements.

Two of the state’s last four elected treasurers pleaded guilty to charges related to payments they collected from would-be investment managers. A 2021 investigation of PSERS by U.S. prosecutors in Philadelphia disrupted the pension plan before ending without allegations of wrongdoing; an SEC probe, so far as we know, continues.

PSERS trustees are now searching for new leaders and have voted to reduce reliance on private investments, though some of the union members on the board have said they believe the stock market’s dive vindicated the former management.

There’s another reason Shapiro’s future appointments might not rush to dump Wall Street and leave it to Vanguard: Devotees of “carbon-neutral” energy, gathered under the umbrella group Vanguard S.O.S., last week expressed their disappointment that Vanguard abruptly ended its modest engagement with Net Zero Asset Managers (NZAM), a group including large, mainstream money managers committed to pressuring U.S. companies to burn less gas and coal over time.

Vanguard pulled out of NZAM after attorneys general for 13 Republican-run states urged federal regulators to review whether Vanguard should be allowed to buy utility stocks, if the climate actions it briefly backed are likely to boost energy costs or threaten investor returns.

Pennsylvania, a fossil fuel-producing state where Shapiro is leaving the attorney general’s office to serve as governor, didn’t join the protest. But leaders are left with a political question: Does this sign-waving struggle over Vanguard’s green soul make it harder for a Democratic governor to risk moving billions to the firm?

And does Shapiro need to care? He hasn’t stocked his transition team with a lot of Wall Streeters, though there are home-state business people, led by Thomas Hagen, a top Shapiro donor and head of Erie Insurance. A couple of business-friendly team members told me privately that they don’t know what the governor is going to do about the pensions, or the trustees he gets to name, to help keep watch as the billions flow.

We’ll just have to wait and see.