Pensions Squeezing GPs on Fees?

James Nash and Stacie Servetah of Bloomberg report, California, New Jersey Pensions Squeeze Fee Savings:

Pension system investment directors overseeing more than $217 billion in California and New Jersey cut millions of dollars in projected costs by reducing the fees they pay to asset managers.

The $146.4 billion California State Teachers’ Retirement System, the nation’s second-largest public-pension fund, has reduced the fees it pays to money managers by an average of 15 percent since June 2009, Chief Investment Officer Christopher Ailman said yesterday in a board meeting. In New Jersey, the pension-investment manager said it negotiated at least $40 million of fee and expense cuts during the next five years.

Pensions around the nation are grappling with unfunded liabilities estimated at more than $3 trillion in a 2010 study by Professors Joshua Rauh and Robert Novy-Marx. Recession losses still haven’t been fully recouped. In December, the California fund was valued at 9.7 percent less than in June 2008, when it had assets of $162.2 billion. Plans have dialed back management fees as they try to rebound.

“We’re trying to drive that lower,” Ailman said of the fees charged by private-equity fund managers, which often amount to 2 percent of assets and 20 percent of profits. Partly, the fund is trying to make sure it isn’t covering costs that the managers should pay, he said at the meeting in West Sacramento.

“We’re very focused on what expenses the general partner bears as opposed to the limited partners,” Ailman said. In September, the California fund said its 2009 management expenses were $139 million less than projected.

Focus on Profit

The pension has reduced annual management fees paid to private-equity firms since July 2009, Ailman told the plan’s governance committee. He said the objective was to get investment managers to focus on increasing the plan’s profit.

The pension spent $617.7 million on asset-management fees in 2009, according to a September report. As of June 2009, the plan listed 847,800 members and beneficiaries on its website.

In New Jersey, Timothy Walsh, director of the state Treasury Department division that manages pension investments, said officials are seeking additional savings beyond the $40 million already negotiated with alternative-investment funds.

“Once negotiations are complete, the state will realize at least $50 million in secured savings over the next five years,” Walsh said yesterday in a statement.

Fee Reductions Sought

The New Jersey division sought fee and expense cuts from private managers after paying $125 million last year, Walsh said in October. Alternative investments also include hedge funds, real estate, commodities, infrastructure and bank loans.

New Jersey has fewer than 20 alternative-investment advisers and isn’t identifying them, said William Quinn, a spokesman for the Treasury Department. Quinn declined to disclose the new terms of its agreements with the managers.

The savings are spread equally over five years, for annual reductions of about $8 million, Quinn said. The fee reductions coincide with proposals from the division to increase the maximum share of holdings that can be placed in alternative investments to 38 percent from 28 percent, Walsh said.

The division manages investments for seven pension funds that provide benefits to about 800,000 working and retired teachers, police officers and government employees. As of Dec. 31, the division said pension fund assets were valued at $70.8 billion, with about $12.1 billion allocated to alternatives.

Funding Gap

New Jersey’s unfunded pension liability rose $8.05 billion, or 18 percent, to $53.9 billion as of June, Treasurer Andrew Sidamon-Eristoff said in December. The state has failed to make pension contributions since fiscal 2008, when it paid $1 billion under former Governor Jon Corzine, a one-term Democrat.

Governor Chris Christie, a Republican who took office in January 2010, skipped a $3 billion pension payment for the fiscal year that began July 1 to help close a $10.7 billion budget deficit. He has said he would restart payments into the system with a partial contribution of $512 million this year if the Democratic-led Legislature acts on his proposals to scale back benefits.

In their study of state and local government pensions, Northwestern University’s Rauh and the University of Rochester’s Novy-Marx estimated states’ unfunded pension liabilities at about $3 trillion, based on Treasury discount rates. They extrapolated another $574 billion in uncovered local-government obligations, based on an examination of 77 plans.

Some thoughts on this article. It always struck me as odd how hedge funds and private equity funds were able to collect 2% management fee and 20% performance fee. To be sure, some deserve it, but most don't. You should be paying 2 & 20 for real alpha, not leveraged beta. If pension funds are doling out mega fees for "alternatives", they should stop and think, is it worth it? Can they replicate certain strategies internally at a fraction of the cost?

I know they can but to do this they have to attract qualified people and pay them. CalSTRS doled out $618 million in asset manager fees in 2009 and New Jersey paid out $125 million in fees last year. That's fine if they're niche or complimentary strategies that cannot be replicated internally, but I suspect that a lot of strategies can be replicated internally at a fraction of the cost. This includes enhanced indexing, fundamental stock picking, L/S equity, merger arb, convertible bond arbitrage, TAA, direct private equity deals and co-investments.

Think about it, $618 million and $125 million is a lot of dough. The problem is that most US public pension funds are scrutinized so they have ridiculous compensation systems. This forces them to go to outside managers and dole out huge fees because they can't attract competent people to do the job internally at a fraction of the cost.

So now pensions are squeezing GPs on fees. It's only normal since they're trying to control costs. I just think there are smarter ways to control costs than squeezing GPs on fees.