State-subsidized pension funds for Pennsylvania state workers and teachers said last week that their 2007 investment returns were far in excess of U.S. stock and bond market indexes.

The returns were so good that they left many investing professionals wondering how they could have been achieved in such an awful environment.

The $76 billion Pennsylvania Public School Employees' Retirement System said it earned 13.8 percent for the year. The $35 billion State Employees Retirement System said it did even better, at 17.2 percent.

By comparison, the benchmark Russell 3000 U.S. stock index was up just 5.1 percent. U.S. bond indexes used by the funds as pension benchmarks did little better than the stocks. SERS Chairman Nicholas Maiale said his system's numbers put it "among the top 5 percent of large public pension funds."

The pension systems credited the strong numbers to private-investment managers that collected a total of $640 million in fees from the two funds last year.

The high returns enabled SERS to slow the expected increase in the state's payroll contribution that helps keep the system solvent. PSERS said it should actually be able to cut its expected contribution from the state and local school districts for next year.

The pension reports left other investors envious. Are the state's managers really that much smarter than other pros, or the investing public?

"One would like to know what they were invested in and how they managed this spectacular performance," said Bernard McCabe, senior mathematician at Independence Advisors Inc., of Wayne.

A closer look at the numbers shows the investment categories for which the pension systems reported the highest returns are also the hardest to verify.

Both PSERS and SERS reported 2007 results that were above their overall average from three categories - private equity, real estate and commodities. Foreign stocks also reported big gains.

For both private equity and real estate, the pension reports excluded data from the fourth quarter of 2007, when the global decline in credit markets hurt asset prices. For the fourth quarter, future reports should show that "returns may be lower as compared to recent returns, but still above the benchmarks," said PSERS spokeswoman Evelyn Tatkovski.

Also, returns for private equity and real estate include estimates of the current value of assets that are not publicly traded and may be difficult to sell in the current difficult credit markets. Tatkovski said PSERS sold real estate investments made long before the downturn, so it was still able to book a significant profit in 2007.

The funds did not make year-end data available for individual private-equity and real estate funds. SERS will make that data available after its next board meeting March 14, said SERS spokesman Robert Gentzel.

Commodities, the smallest category for both funds, have soared in value with the decline of the U.S. dollar. Foreign stock values also benefited from the dollar's decline, and international diversification helped both funds. SERS started commodities investments in 2001, Gentzel said. "They had not anticipated the tremendous returns we have achieved - but we'll take 'em," he added.

At PSERS, U.S. stock investments returned 4.8 percent for the year, slightly trailing the benchmark Dow Jones Wilshire 5000 index (up 5.6 percent), as they have for the last five years.

By contrast, SERS said its U.S. stock managers trounced the Russell 3000 index, returning 9.5 percent, compared with 5.1 percent for the benchmark.

But the SERS U.S. stock returns include profits reported by two multibillion-dollar hedge fund accounts managed by Blackstone Alternative Asset Management L.P., of New York, and Pacific Alternative Asset Management Co. L.L.C., Irvine, Calif.

Those hedge funds "did particularly well in 2007," and hedge profits accounted for "almost all the difference" between the overall "U.S. equity" profit and the benchmark's lower increase, Gentzel said.

SERS has in past years also included two other large hedge fund managers, Mesirow Advanced Strategies, of Chicago, and Morgan Stanley Alternative Investment Partners, of West Conshohocken, in its U.S. equity results.

In this year's report, however, those two managers were moved to a new category, "Absolute Return," whose profits were not reported. Gentzel said their returns were unavailable last week.

SERS's hedge fund numbers were also boosted by profits from more than $10 billion worth of "swap" investment contracts designed to mimic the performance of the major stock indexes, Gentzel said.

Legislators who met with SERS and PSERS officials did not show concern about the funds' performance reporting. They were more interested in seeking ways to boost the funds' payments to retirees, as inflation erodes pension values, according to Gentzel and others who attended.

"I have been retired for nearly 12 years and have had but one increase in my pension in all these years," said Marjorie Lukens, who taught school in Abington for 27 years and receives a net $3,170 a month after tax and health insurance deductions. "As you can imagine, health care and many other things have increased, so a cost-of-living allowance is of huge interest to me."

Contact staff writer Joseph N. DiStefano at 215-854-5194 or