For decades, state pension funds have relied on the private equity industry to invest retirement savings for teachers, firefighters and other public-sector employees. But in recent years, critics of alternative assets have argued that pension managers, who oversee some $4.5 trillion across the US, would be better served investing in low-cost index funds that track the S&P 500 and avoiding PE's high fees.

This past week, public pension fund managers threw PE detractors more red meat, raising larger questions about the longstanding practice of smoothing returns and who exactly holds pension fund managers accountable when they underperform.

In Pennsylvania, a half-dozen trustees on the board of the Pennsylvania Public School Employees' Retirement System, a $64 billion pension fund, have reportedly called for the resignation of executive director Glen Grell and CIO Jim Grossman. The trustees have denounced the pension fund's investment performance and its payment of management fees totaling more than $4.3 billion over the past four years, exceeding the roughly $4.2 billion paid in by fund beneficiaries, The Wall Street Journal reported.

Oh, and in March the FBI launched an investigation into PSERS over a possible bribery, according to The Philadelphia Inquirer. And Pennsylvania state senator Katie Muth reportedly sued the pension over a lack of transparency around its investment decisions. Not exactly the kind of publicity a pension fund wants.

Meanwhile, a former teacher last year sued the State Teachers Retirement System of Ohio, which manages some $80 billion, after it ended cost-of-living increases to retiree benefits in 2017. All while paying private equity and hedge funds a whopping $4.1 billion in fees over the past decade, according to a report commissioned by the Ohio Retired Teachers Association, an advocacy group.

In both instances, watchdogs have called attention to pensions overstating their return performance. In a recent analyst note, PitchBook detailed a strategy PE firms use to downplay a portfolio's volatility, known as return smoothing. In Pennsylvania, the misdeed had significant consequences. By botching a critical financial calculation by a third of a percentage point, it spared pension dues from increasing for around 100,000 state employees, with the shortfall going to taxpayers. In March, PSERS admitted the error and acknowledged it would have reportedly cost taxpayers at least $25 million.

In Ohio, STRS spokesman Nick Treneff in an interview with NBC disputed the findings in a report commissioned by the Ohio Retired Teachers Association, downplaying a high-cost PE fee structure that has included charging $143 million for managing the pension's money (excluding fees).

Richard Ennis, co-founder and former CEO of EnnisKnupp (now Hewitt EnnisKnupp), a consultant firm that advises institutional investors, has tracked fund performance for more than a decade. And he says public pension fund returns have rarely outperformed public markets.

"The Georgia Teachers pension fund is the only one in my study to achieve a statistically significant positive alpha," Ennis told me via email. "They have zero alternative investments and a total cost of operation of about 10 basis points. Nevada's pension fund, which is almost entirely indexed, also did well."

In Ohio, STRS said its PE and hedge fund holdings returned 6.7% annually over the past five years, well below publicly-traded benchmarks. That was bad news for teachers, investors and the pension managers, which dedicated some 18% of its portfolio to PE, outpacing many peers.

But don't bet on recent events to cause pensions to abandon PE. The asset class has continued to rack up billions in commitments in recent years. Dry powder has reached record levels. And PE has convinced its backers it can soften economic downturns, with some firms even thriving during the pandemic.

Ennis disagrees.

"This is a myth, utterly without precedent," he said. "The argument is meritless propaganda of the alts industry, probably born of the return smoothing associated with alts."

This isn't the first time a pension's cozy relationship with PE has caused trouble. Last year, Ben Meng resigned as CIO of Calpers, the largest US pension fund, after it was reportedly revealed he had failed to disclose he had personal investments in Blackstone, The Carlyle Group and Ares Management—while Calpers allocated some of its $450 billion in assets into those firms' funds.

Pension fund returns over the 12 years ended June 30, 2020 have trailed public indices by 155 basis points annually, according to estimates presented by Ennis in a recent report. Since pensions collectively manage some $4.5 trillion in assets, that costs US taxpayers approximately $70 billion annually, a figure Ennis described as "astonishing." Broken down by each eligible taxpayer, that equates to nearly $500 more in annual taxes per individual, according to MarketWatch.

Put another way: It might be a good time to reevaluate how pensions are spending their money. It impacts everyone.

"Pension benefits are fixed and in most states guaranteed," Ennis said. "The taxpayers will foot the bill for the shortfall."