CalPERS Pushes Ahead in Fight to Cut Costs

The California Public Employees’ Retirement System (CalPERS) investment office said it will continue to focus on enhancing cost effectiveness and evaluating risk as part of its 2015-2017 roadmap.

The roadmap, presented at an investment committee meeting Monday, is part of CalPERS’ 2020 Vision—a five-year effort focused on “simplifying the investment portfolio, simplifying the organizational structure, focusing on risk cost and complexity, and improving the level of collaboration within the investment office,” said Chief Operating Investment Officer Wylie Tollette.

Already, CalPERS said it has made progress on cutting costs: The investment office saved $217 million in the 2014-2015 fiscal year, primarily through improved fee structures for real assets and private equity investments. These savings included $196 million of reduced ongoing fees and $21 million in one-time savings.

The roadmap also pushes for enhancing the pension’s capital allocation framework, improving its investment platform and controls, and continuing to integrate investment beliefs into the investment process, including environmental, social, and governance (ESG) considerations. CalPERS’ latest ESG effort was signing the Paris Pledge for Action, a commitment to support and implement the climate change agreement reached at COP21.

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The ultimate goal, Tollette said, is to manage the investment portfolio in a “cost-effective, transparent, and risk-aware manner in order to generate returns to pay benefits.”

“The simplicity and clarity of that mission are very important,” he continued. “That’s what we are focused on doing.”

CalPERS’ roadmap includes 36 initiatives that are already in progress. Some, such as collecting and reporting private equity fee data, have already been implemented, while others are still in the development stages.

“One of the essential challenges of driving change is you have to repave the road while you’re driving on it,” Tollette said. “We believe we are effectively accomplishing that.”

In addition to improving fee structures, CalPERS said it has also made progress in fostering relationships with diverse portfolio managers. The pension also completed the initial printing of its carbon footprint and finished pricing and valuation procedures for all asset classes.

Looking further ahead, the $288 billion fund also outlined potential areas to focus on as part of a 20-year plan, including technology, business models, the market environment, physical location, and talent.

“At this point, we are really just trying to figure out exactly what questions to focus on for looking at something like the 20-year vision,” Tollette said. “None of us have a crystal ball of how the world might work.”

Performance fees, or carried interest, may not be the only type of controversial private equity fees.

Private equity firms took home nearly $20 billion in transaction and monitoring fees, or 3.6% of all earnings, from some 600 acquired companies over the past two decades, according to academics.

These fees are not well documented and are often overlooked by companies and limited partners (LP), argued University of Oxford’s Saïd Business School’s Ludovic Phalippou and Christian Rauch, and Frankfurt School of Finance & Management’s Marc Umber.

“These fees are contentious because they are charged by GPs [general partners] to companies whose board is controlled by these same GPs,” they wrote. “LPs negotiate only on management fees, carried interest, and the fraction of portfolio companies fees that is rebated against the management fees due.”

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According to the paper, these “portfolio companies fees” include not only transaction and monitoring fees, but also termination, director, commitment, financial advisory, and capital market fees. Even some business expenses such as the use of private jets are included in some deals, the authors said.

Specifically, the research found GPs took home $10 billion in transaction fees, $8.1 billion in monitoring fees, and about $1.5 billion in other fees from 1995 to 2013.

Furthermore, Phalippou, Rauch, and Umber said from 2008 to 2014, the largest four private equity managers (Carlyle, KKR, Blackstone, and Apollo) earned $16.5 billion of carried interest, $10.8 billion of management fees, and $2.5 billion in “net monitoring and transaction fees.”

The authors also applied these calculations to fees paid by the California Public Employees’ Retirement System (CalPERS), and said it would have paid $2.6 billion in portfolio company fees across funds with vintage years 1991 to 2008, “which they have not tracked so far.”

The $288 billion pension announced in November that it had paid $3.4 billion in performance fees for $24 billion in net gains since the private equity program’s inception in 1990.

“These fees are commonplace and are not a new phenomenon,” the authors wrote. “Even if these fees were to be 100% refunded to investors going forward, we note that the amounts charged are economically relevant and significantly impact the finances of a large number of corporations.”