The $5 trillion in assets controlled by state and local pension systems play a prominent role in U.S. financial markets, for instance as the largest source of capital for private equity firms and hedge funds. Routinely underfunded by politicians and thus under pressure to deliver implausibly high returns, these pension funds turn to risky and expensive alternative investments that tend to deliver subpar performance, often underperforming simple market index funds. Only five out of 52 state pension systems outperformed a basic 60% equities, 40% bonds portfolio over the past decade.

Bad incentives give pension managers rational reasons to continue investing this way. Alternative investments are illiquid and opaque, which means that funds are locked up for years and difficult to value along the way. No one knows how volatile they are or how well they are performing. Both politicians and the managers they appoint are quite happy to have their hands tied and their results unknowable. And as for alternative investment managers, they go on collecting their fees—for holding the money, for the transactions they conduct, sometimes for advising the firms they buy, regardless of their success. With the pensions guaranteed by state and local governments, it is taxpayers who are ultimately left to foot the bill.

The United States should require transparent and accountable investment of capital imbued with public purpose, like state and local pension funds and tax-advantaged endowments. Fund managers proposing to earn fees by investing public-purpose capital should be required to publicly disclose upfront the benchmarks that they propose to outperform, and then to publish details of their annual performance. The SEC should establish clear reporting standards for comprehensive financial statements from such entities, including the timing and amount of all cashflows into and out of the fund, deal size and structure for all transactions, and annual marked-to-market valuation for each asset held. Taken together, this information would allow both pension managers and the public to understand the risks being taken, the returns reasonably expected, and the results achieved, and make fees contingent on those results being good ones.