All Fees, No Beef?
The Lenape tribe got a better deal on the sale of Manhattan island than New York City’s pension funds have been getting from Wall Street, according to a new analysis by the city comptroller’s office.I thank Josh Brown, the Reformed Broker, for bringing this story to my attention. If you ever needed proof that the governance at U.S. public pensions is all wrong, just refer to this article to see how useless investment consultants have effectively hijacked the entire investment process to direct U.S. public pension assets to a bunch of overpaid hedge fund and private equity managers.
The analysis concluded that, over the past 10 years, the five pension funds have paid more than $2 billion in fees to money managers and have received virtually nothing in return, Comptroller Scott M. Stringer said in an interview on Wednesday.
“We asked a simple question: Are we getting value for the fees we’re paying to Wall Street?” Mr. Stringer said. “The answer, based on this 10-year analysis, is no.”
Until now, Mr. Stringer said, the pension funds have reported the performance of many of their investments before taking the fees paid to money managers into account. After factoring in those fees, his staff found that they had dragged the overall returns $2.5 billion below expectations over the last 10 years.
“When you do the math on what we pay Wall Street to actively manage our funds, it’s shocking to realize that fees have not only wiped out any benefit to the funds, but have in fact cost taxpayers billions of dollars in lost returns,” Mr. Stringer said.
Why the trustees of the funds — Mr. Stringer included — would not have performed those calculations in the past is not clear.
Mr. Stringer, who was a trustee of one of the funds when he was Manhattan borough president before being elected comptroller, said the returns on investments in publicly traded assets, mostly stocks and bonds, have traditionally been reported without taking fees into account. The fees have been disclosed only in footnotes to the funds’ quarterly statements, he said.
The stakes in this arena are huge. The city’s pension system is the fourth largest in the country, with total assets of nearly $160 billion. It holds retirement funds for about 715,000 city employees, including teachers, police officers and firefighters.
Most of the funds’ money — more than 80 percent — is invested in plain vanilla assets like domestic and foreign stocks and bonds. The managers of those “public asset classes” are usually paid based on the amount of money they manage, not the returns they achieve.
Over the last 10 years, the return on those “public asset classes” has surpassed expectations by more than $2 billion, according to the comptroller’s analysis. But nearly all of that extra gain — about 97 percent — has been eaten up by management fees, leaving just $40 million for the retirees, it found.
Figuring out just how big a drag the fees were on the expected returns of the funds overall was not easy, Mr. Stringer said.
Scott Evans, the comptroller’s chief investment officer, had to work backward from the footnotes in the reports to estimate just how much had been paid each year to a long list of Wall Street firms that managed investments in the public markets. He then calculated that those fees, combined with the significant underperformance of the investments in private assets like real estate, amount to a whopping negative — a drag of more than $2.5 billion — since the end of 2004.
Leaders of unions whose members have stakes in the funds said they expected the analysis to lead to changes.
“The fees are exorbitant and we’re not getting a good return on our money,” said Henry Garrido, executive director of District Council 37 and a trustee of the New York City Employees’ Retirement System. “That’s an insane process to keep doing the same thing over and over.”
Mr. Garrido said he saw Mr. Stringer’s emphasis on the high fees as a continuation of the efforts of his predecessor, John C. Liu, to improve controls over the managers of the pension funds.
Michael Mulgrew, the president of the United Federation of Teachers, said he was happy that his union’s pension fund, the Teachers’ Retirement System of the City of New York, had been performing well. But he said the fees paid to some managers were “ridiculous” and should be renegotiated if those managers are retained.
“Education’s always being put under reform; maybe some of these financial practices should be put under reform as well,” Mr. Mulgrew said. He praised Mr. Stringer for taking aim at a line of business that has been very lucrative for Wall Street.
“You are talking about messing with a practice that they don’t want messed with,” Mr. Mulgrew said. “I give the comptroller credit. He’s jumping feet first into this one.”
On Wall Street, it's all about fees, which is why I commend New York City Comptroller Scott M. Stringer for releasing an analysis by his office showing that Wall Street money managers failed to provide value to the City’s pension funds over the last 10 years.
And a fraction of that $2.5 billion in external fees could have being used more wisely, like hiring experienced money managers to manage assets across public, private and absolute return/ hedge fund strategies internally, saving these NYC pensions billions in fees, not to mention they would have performed a lot better. But to do this properly, these U.S. public pensions need to first implement the right governance model and compensate their public pension fund managers properly.
I personally think every single public pension fund in the world, including our coveted top ten pensions in Canada, should include their own analysis in their annual report clearly demonstrating how much added value all their external money managers are providing after fees. More importantly, there should be laws passed forcing all public pensions to list all their external managers and the fees they pay them (and they should do the same for brokers, consultants, service providers, etc.).
Immediately, a lot of people, including the folks at Ontario Teachers and HOOPP, will object and say "we don't want to share that information for competitive reasons." I couldn't care less what they or other large pensions claim, it's high time they are all held accountable to the highest level of transparency.
My philosophy is simple: if you're a public pension, you should be held accountable to the highest level of disclosure and provide detailed information on all investments and fees paid out to external money managers and service providers. The same goes for all internal investment activities, we need a lot more transparency on costs and performance. Period.
I know this will irk many secretive pension fund managers and even more secretive hedge fund and private equity managers but I really think it's high time politicians all around the world pass serious laws to introduce a lot more transparency and accountability to public pensions, forcing them to disclose a lot more than they're currently publicly disclosing.
As for hedge funds, this article just exposes why it's high time to transform their fees. There is a reason why CalPERS nuked its hedge fund program and why other large pensions followed suit. When they did their own internal analysis, they probably found they weren't getting the performance after fees or it was an investment activity that was too operationally taxing for them and they weren't willing to commit the needed resources to properly invest in hedge funds.
Whatever the case, in a historically low rate, low return world where global deflation increasingly looks like a real possibility, global pensions are putting the screws on their external money managers, especially high fee alternative investment managers charging them alpha fees for leveraged, sub-beta returns. And I expect this trend to continue as the institutionalization of alternative investments gathers ever more steam.
When it comes to external money managers, especially those high fee hedge funds and private equity funds, investors have got to ask themselves one question: "Where's the beef???"
Speaking of beef, where are your donations and subscriptions to this incredible blog? Get to it folks, you have no idea how lucky you are to read very insightful, timely and free comments from the world's best, most under-rated, under-appreciated and humble (lol) senior pension and investment analyst!! -:)
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