Time and again, Florida's pension managers were told they could reduce costs and generate better returns if they relied more on investment strategies that didn't try to beat the market.
But over the years, the State Board of Administration hired new active managers, paid more fees — and lost hundreds of millions of dollars in additional retirement savings.
In 1989, Charles L. Lester, then Florida's auditor general, evaluated 17 outside equity money managers. The state had paid 16 of them $6.8 million in 1988 to pick stocks. Thirteen of the 16 underperformed the S&P 500, a widely used index and benchmark for the U.S. stock market. A 17th outside manager was paid $191,000 to handle stocks that simply tracked the S&P 500.
Lester's audit also faulted the SBA's system of selecting private money managers, negotiating their fees and monitoring their performance.
Cliff Hinkle, then executive director of the SBA, responded that his staff had begun to invest more pension assets in passive strategies.
But in 1992, the auditor general issued another report similar to the first one: Stock managers trying to beat the market generally did worse than passive managers simply trying to duplicate a market index. The value of the pension fund would have increased by $177 million over five years if the SBA had simply stuck with passive managers, the audit estimated.
The audit noted the SBA had taken actions to improve managers' performance. Ash Williams, who led the SBA at the time, agreed to "closely monitor" them.
The cycle repeated itself.
In 1996, shortly after Williams left for a private investment job, another audit raised "concerns'' about the SBA's handling of its stock portfolio. While the pension fund exceeded its overall investment goals, domestic equities underperformed in 1995, according to the Legislature's Office of Program Policy Analysis and Government Accountability. The fund would have earned an additional $566 million if its domestic equities had matched the return of the S&P 500 Index.
Barbara L. Jarriel, then the agency's acting executive director, agreed with a recommendation that the staff "closely monitor'' the stock managers' performance.
In 1998, legislative auditors and pension managers argued publicly over indexing. An audit again found "significant under-performance'' among stock managers though the fund had exceeded its investment goals. Florida would have earned an additional $612 million in 1997 had it relied on passive strategies. It also would have saved $49 million in investment management fees. The auditors urged the SBA to invest its entire $50 billion U.S. stock portfolio with passive-style managers.
The SBA strongly disagreed. Then-executive director Tom Herndon defended the use of active management strategies and called the auditors' analysis inadequate, meaningless, distorted and full of errors.
While the SBA was considering more passive strategies, Herndon noted that other public funds had rejected the "completely passive approach.''
"We do not believe that 100 percent passive equity investing is appropriate, realistic or safe!" Herndon wrote to the governor, comptroller and treasurer.
In 2000, another legislative audit found that the pension fund could have earned an additional $400.2 million in one year by investing just 80 percent of its domestic stocks passively (instead of its actual allocation of 59 percent). Had the SBA turned over its entire $60 billion domestic stock portfolio to passive-style managers, the agency would have increased earnings by $799.4 million.
"Particularly in situations when protecting against undue risks is critical (as in the case of investing retirement system assets), it is very difficult for investment managers to 'beat the market' over extended periods,'' the 2000 audit said.
Herndon responded by quoting part of his response to the 1998 audit: ''A completely passively managed domestic equities program would be contrary to the interests of the (Florida retirement) beneficiaries and Florida taxpayers.''
As of March 2011, about 51 percent of the pension fund's $78.6 billion global stock portfolio was actively managed. The SBA says that for stocks and bonds, it plans to increase its use of passive index strategies over time.
Sydney P. Freedberg, Times staff writer