The New York Times and the Wall Street Journal published two interesting perspectives on pension fund fees recently. In the first article, entitled “Strapped Pension Funds, and the Hefty Investment Fees They Pay”, Gretchen Morgenson cites the severe underfunded status of many US public pension funds and against this describes the fees paid to alternatives managers in particular, compared to the actual returns (v. traditional indices) recently experienced by these investments. There is much to unpack in this article which hops around various subjects besides fees, including the fiduciary obligation of pension fund staff not just to beneficiaries but also to tax payers. More on that at a later stage. With respect to fees though, and asset allocation, she calls the $1.3 trillion in unfunded liabilities across the US a “mighty deep hole” and claims that “(t)hey seem to think that swinging for the fences with the more exotic strategies will close the yawning gap”.
Cherry picking the recent lack-luster years of performance for alternative strategies is not exactly a “fair fight”. The multi-year expansion since the Great Financial Crisis of 2008 has benefited a traditional balanced portfolio allocation most of all. In fact a typical 60% equities, 40% fixed income portfolio was even more advantaged due to the fact that fixed income enjoyed a streak of positive performance as it neared the end of what has been a 30 year bull run driven by a downward trajectory of interest rates. Looking forward – which is how all asset allocations are (and should be) set – settling for a traditional balanced portfolio split looks like a terrible idea. Fixed income returns are settling in low single digits, while equity markets look close to full valuations and are represented by a swollen passive and ETF participation. “Swinging for the fences” in a risk controlled, well-due-diligenced way, is essential to meet lofty return targets in the 6-7% range and make any kind of dent in that “yawning gap”. While better transparency and understanding on fees, as well as a need to split the pie more fairly, is always to be desired, we must be very sure not to throw the baby out with the bathwater.
The second article, from today’s Wall Street Journal, cites the difficulty in getting an appropriate handle on total fees paid, especially when portfolios move towards the more complex. Management fees, profit sharing fees and “other” fees, namely transaction, administrative and other miscellaneous charges are often tallied in different places and can be hard to compile. This article describes how Calpers in particular is turning to quant models to properly calculate its fees, and, as might be expected the figures on Calpers $26 billion private equity portfolio (at the end of 2016) are hefty – totally $490 million in profit sharing and $327 million in fees and partnership expenses. This fee load, which comes to over 3% of the total portfolio seems high in absolute terms. However, it is important to note that a profit share, is just that – a profit share – often in excess of a meaningful return hurdle (usually 8% IRR) which the investor must receive before any “profit” is shared. In the current low return environment returns of that nature are not only rare, but essential to incorporate if return targets are going to be met.
There is much to say on this topic, but for now it is critical to separate the realities from the attention grabbing headline figures. Perhaps more facts, fewer figures would be desirable. Making a target return is hard – that is a fact. Let’s not hobble public pension funds by too much ex-post revisionism.