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USF researchers find political bias makes for riskier state pension funds

August 19, 2016
by Hilary Lehman

Around the nation, state pension funds are a hot political issue. Many are underfunded, leading to tough questions. Should state employees be required to contribute a percentage of their own earnings? Should pension programs be offered at all?

It turns out that some of that underfunding might not be inevitable or due simply to the whims of the market. State-run pension funds across the country are only about 70 percent funded, with close to a trillion dollars of underfunded liabilities. Some of these state pension funds are internally managed by state employees instead of by outside corporations or consultants.

USF finance professors Christos Pantzalis and Dan Bradley, along with their former student Xiaojing (Aggie) Yuan –now an assistant professor of finance at the University of Massachusetts Lowell – discovered that for state pension funds that are internally managed, not only is there bias for holding local companies' stocks in these funds - there is bias for politically connected companies, as well.

This results in these funds being riskier and lower performing than their externally managed counterparts – with a loss of about a quarter billion dollars per year for each fund that places undue weight on politically connected stocks. The researchers' paper, "The influence of political bias in state pension funds," was published recently in the Journal of Financial Economics.

"The retirement funds of a lot of voters are at stake," Pantzalis said. "If these are internally managed, there could be strange things going on - and that is indeed what we found."

From the previous research on state pension funds, it was already clear that there was bias for local funds, which could be due to the fund managers having either higher familiarity with the local funds or more information available about them. But the third option was that some of that local bias could be due to political pressures or bias.

That bias existed in the data, with the stocks of local firms that donated to politicians or spent money on lobbying appearing more frequently in the funds - and staying in the funds for longer periods of time than other stocks.

"These internal managers of state pension funds are overweighting these local stocks 20 to 30 percent more than they should," Pantzalis said. "There's a loss of about $225 million per year for each fund that does that."

Pantzalis and Bradley found that for pension funds with trustee boards that were dominated by current or former politicians, the effect was magnified, with those funds tending to make even riskier investments. This effect appears to transcend political party.

Pantzalis said he doesn't have any recommendations for how to fix the problem of political bias.

"The data tells us a very interesting story, and now it's up to the policymakers and the accountants to take over," he said.

Pantzalis did say one thing was clear from the research, though: externally managed funds are a safer bet for taxpayers.

"This is an excellent example of the type of research we advocate for as a college, which is research with impact," said Moez Limayem, dean of the Muma College of Business. "When researchers uncover a difference of almost a quarter billion dollars per fund on average, it's obvious that this research has implications beyond academia."