The Colorado Sun ran an article titled “As retiree pensions shrank, Colorado PERA paid its staff millions of dollars in bonuses”. This article has lots of good and relevant information in it, and this is a legitimate topic to debate. But I was disappointed in some of the things the article left out. There are some significant pieces of relevant information and context that were not included, so I thought I’d take a shot at adding in some of those (believe it or not, I could include more, but I tried to limit myself).
Please Note: I know a fair amount about PERA, but I am not PERA. So it’s possible that I’ve gotten something wrong or that I, myself, have left out important context. But I hope this is still helpful.
Here’s what I suggest you do:
- First, read the original article completely and carefully, and then sit with it for a few minutes to think about what your takeaways are.
- Only after doing that read my annotated version of the article (or if you prefer, as a pdf). Now take a few more minutes and reflect and see if those annotations perhaps give you a more complete picture of this topic.
Most of what I have to say about this is in the comments on that annotated doc, so please read those. But I did want to specifically say three things here.
- I’m a huge fan of index funds. PERA incorporates some index funds into their investments but also practices active management, so you might assume I think PERA should change to index funds. While I don’t think that would necessarily be horrible, it’s important to keep in mind that because PERA keeps investment expenses low, they have beaten their benchmarks (the indexes for their investments). That’s after fees and expenses, including the incentives that this article is talking about. In other words, if PERA had invested just in indexes instead of what they’ve done, and not paid any of those investment professionals anything, the PERA trust fund would have less money.
- I think the structure and the amounts of the incentives for PERA’s investment professionals are definitely topics that are worth examining. There’s no question these folks are highly compensated and it’s possible that a less generous incentive structure would still attract and retain talent while “saving” PERA some money. But as I mention in one of the comments on the doc, the entire incentive budget of $13.1 million (not all of which is actually awarded and spent), works out to 0.0196% of PERA’s $67 Billion investment portfolio. As a comparison, Vanguard’s Total Stock Market Index Fund (VTSAX), charges 0.04%, roughly twice as much. It’s easy to see “$13.1 million” and be outraged, but people’s innumeracy around large numbers (millions vs. billions) often means they don’t understand the true magnitudes involved.
- Personally, I think the question over the structure and/or the amount of the incentives is the wrong question to be asking (or at least the wrong first question). Rather, the question I think should be asked is, “Is there any evidence that providing incentives to investment professionals improves investment performance?” Or, perhaps more succinctly, “Why have incentives at all?”
It’s been a few years since I’ve looked at the research around incentives, but as far as I know the following still holds true. For cognitively complex tasks, incentives don’t improve performance. Incentives only improve performance on routine, non-cognitively complex tasks (think assembly line work). In those cases, they do improve performance. But on anything that requires complex thinking and problem solving, and investing $67 billion certainly does, the evidence shows that there’s no improvement seen from incentives. (Daniel Pink’s “Drive” has a good summary of the evidence.) After all, the unspoken assumption behind incentive pay is that these people just don’t care if they do a good job, but suddenly will do better if you provide them additional monetary incentives. I always felt insulted as a teacher when this idea of “merit pay” was brought up. If I was one of PERA’s investment professionals, I would also feel insulted that people would think I would do less than my best if there wasn’t some kind of “merit pay.”
So if I was King-for-a-day, I would suggest that we get rid of performance incentives altogether and instead raise their base pay significantly. Pay them what they are worth without any gimmicks. I suspect that you likely could pay them between 5% and 10% less than the industry median (after incentives/bonuses), simply because their pay was guaranteed and not dependent on factors that are sometimes out of their control. You would also simultaneously be sending the message that we trust these people to do their best and that they would not have taken the job if they didn’t believe in the mission.
PERA is complex, and it’s very difficult for any stakeholder (including journalists) to understand all of the nuances. (And, as I said, I may not have understood all the nuances either.) But I hope that the annotations helped you understand some of those nuances and provided a more complete picture of this important topic.