(December 2, 2013) – What will $500 million in asset
management fees buy? A heck of a lot of trouble, judging by recent controversy surrounding
two US public pension funds’ investment expenses.
New York City and South Carolina’s retirement systems each
shelled out just under half of a billion dollars to asset managers in the most
recent fiscal year. Both public defined benefit schemes outsource effectively
all of their assets to external investment firms. Allocations to alternatives
are by far the most expensive part of each system’s portfolio.
The catch? Between its five pension funds, New York City’s
assets total $144 billion. South Carolina spends roughly the same on a $27
billion portfolio.
Furthermore, in the 2013 fiscal year, New York City’s funds
returned 12.12% and South Carolina’s gained a net 9.9%. The former has likewise
outpaced its southern peer over three- and five- year performance periods.
But both organizations have come under fire in recent weeks
for their half-billion investment expense tabs. Here is an in-depth look as to
why, and what those in charge are doing about it.
New York City
Retirement Systems ($144 billion AUM)
“Wall Street Fees Paid by NYC’s Pension Funds Climb 28%,” announced
a Bloomberg headline on November 22, following the release of the comptroller’s
annual report for fiscal 2013. It’s the story no PR person wants to wake up to.
New York City’s five massive retirement funds have long been
characterized as a governance nightmare, including by their most recent CIO
Larry Schloss and by this publication. As with South Carolina’s
state system, New York City outsources all of its asset management, leading to
higher fees than it might otherwise incur.
“Of the top 10 US public pension funds—NYC is
number five—we’re one of two outsourcing everything,” Schloss told aiCIO last year. (The other fund is
Washington State’s.) “It hasn’t at all changed in 70 years. We’ve gone to the
moon and invented the internet in 70 years. You’d like to think you can change
this, especially with the talent present here in the world’s financial
capital.”
Near the end of his tenure, Schloss put forth a
proposal to start the insourcing process. It hasn’t gained traction since then,
although his estimated timeline for full implementation was an astonishing 10
to 20 years. Until then, the New York City pension system’s costs of doing
business land in the pockets of Wall Street-types. Based on the latest fee figures
and the official reasoning behind them, those costs will likely continue to mount.
The 28% figure cited by Bloomberg is accurate: New York
City’s pension funds spent $472.5 million on investment fees in the 2013 fiscal
year, and $370.2 million the year prior. Add in the defined contribution plans
and health benefit funds, and the recent payout amounts to $499 million, which
is $105 million higher than the previous year. But nearly half of the rise in
management expenses can be attributed to growth in the pool of assets needing
to be managed. The funds closed FY2013 with a collective $137.4 billion, and 2012
with $122.1 billion—a rise of 13%.
When reached by aiCIO,
a spokesperson for the Comptroller’s Office was audibly frustrated at the
“rising fees, stagnant performance” angle prevailing in press reports on the
data. The comptroller, who is responsible for the retirement funds, pinned the
jump in fees on changing asset allocation as opposed to a Wall Street feeding
frenzy.
“It’s
misleading to cherry pick one year and compare a rise in fees with the rate of
return,” the office said in a statement. “Fees rose in FY2013 consistent
with the recent expansion into alternative asset classes that diversify the
portfolio against events like the stock market collapse in 2008. By making
these alternative investments, the funds have helped reduce the risk in the
portfolio for both pensioners and taxpayers, particularly in times of stock
market distress… The fact is that many alternative investments, such as private
equity and real estate, have front loaded fees and don’t generate returns for
several years.”
Allocations
to alternatives have risen over the past few years, although not by a huge margin
according to the latest available data. Taken together, private equity, private
real estate, and hedge funds amounted to 11.2% of the systems’ portfolio as of
August 31, 2013. A year prior, that portion was 11.1% and in 2011 it was 9.7%. Change
comes slowly to New York City’s retirement funds.
From a fee perspective, that’s a good thing. The city’s
biggest fund, the $47 billion New York City Employees’ Retirement System, is
also the largest municipal pension scheme in the United States. During the 2012
fiscal year, alternatives accounted for 15.8% of the portfolio but 63.5% of its
total fee spending.
There is a consensus among consultants and alternative
managers alike that fees have fallen overall since the financial crisis. This
trend in alternatives, like New York City’s rebalancing towards the asset
classes, is operating in the margins. South Carolina’s $11 billon alternatives
program, representing nearly half of its total portfolio, is not.
Continues on following page...
South Carolina Retirement System ($27
billion AUM)
The
South Carolina Retirement System Investment Commission (RSIC) has initiated a
major shift in asset management in an attempt to reduce its extraordinarily
high annual fees, last clocking in at $419 million. Spearheaded by the newly appointed COO Greg Ryberg,
the commission has requested $1.2 million from the state legislature to build
out internal management and back office capabilities.
“Our
goal is to bring a lot of the functions internal, to control our destiny
relative to the fees,” former state Sen. Ryberg told aiCIO. “We are looking to staff up in order to handle more of our
investments and operations, and to establish proper personnel level.”
The
$27 billion fund’s management fees are significantly higher than those of other
pension plans—the fees equal 157 basis points (bps) of total assets compared to
an average of 57 bps, according to fund consultant Hewit EnnisKnupp.
The
consultancy further reported that South Carolina was paying well above the norm in performance-based fees and add-on expenses. It recommended not only reducing
current fees but also aggressively negotiating terms when hiring new managers.
According
to the investment commission’s annual report, fees have jumped 33% from the last
fiscal year. The report also revealed that strategic partnership costs have
accounted for more than half of the hefty sum—as of June 30, 2013, RSIC paid $233
million to its asset management "partners."
“There
are good fees and bad fees,” Ryberg said. “We hope to reduce the bad fees—those
we pay upfront on committed capital. Unfortunately, the price of admission into
some of these funds is extremely high.”
Ryberg
continued to say that the commission is on track to reducing its number of strategic
partnerships: “When we first made investments, we didn’t have the staff to do
all of the due diligence so we had to hire external managers. But some of these
strategic partnerships will unwind and untie.”
South
Carolina has already curtailed six of its original 14 partnerships and is
expecting to lose two more in the near future.
However,
this enterprise to cut management fees has been overshadowed by a very
public—and personal—dispute between State Treasurer Curtis Loftis and COO
Ryberg. Both men hold sway over the fund as RSIC voting members.
“I
find myself in an odd position as a member of the commission,” Loftis told aiCIO. “I want to support the commission
but as treasurer, I see a big problem with the top officers. We lack a moral
core—particularly in the way we report our operations.”
Loftis
said a move from active to passive management would significantly help relieve
the fund of its substantial fees—and that appropriate due diligence on the
commission’s internal staff is key.
“I’m
concerned about due diligence on ourselves,” Loftis said. “We hire consultants
everyday to perform due diligence on our external management. Why don’t we do
the same for us? We need to talk about whether the commission is capable of
managing these large sums of money and exactly how much we’re losing and who’s
losing it.”
Transparency,
however, is something RSIC still needs work on, according to Loftis. He claimed
the commission has remained quiet on a $1 billion loss in its synthetic overlay
program run by Russell Investments over the last five years. “Nobody owned this
loss,” he said. “The commission’s never really addressed it and until we
resolve these types of issues, we’re working at our own peril.”
The
treasurer also revealed that until recently, RSIC’s management fees have been
shown “discreetly” on its audited financials.
“Under
the investment expense line, we only showed about 20% to 25% of our fees. So
instead of showing $300 million, we only showed $50 million,” Loftis said.
“Over the last three years, $750 million in fees was just netted from the
account and was not described elsewhere on the statement.” He said fiscal year
2013 was the first time RSIC has revealed the entirety of its fees, alarming
not only the commission but also the South Carolina general assembly.
Ryberg
directly opposed Loftis’ claims: “The South Carolina public pension plan is the
only plan in the country that fully discloses its fees. And as for our
disclosures in the past, we have always been consistent with every other
pension plan in the country.”
Loftis
continued to state that certain members of the commission have been using the
$27 billion as their own cash cow. He said Chairman Reynold Williams and his
law firm even made $150,000 off RSIC’s investments in American Timberlands.
“These
unelected bureaucrats like the way they’ve been doing business,” Loftis said.
“They treat the commission like it’s their own baby. They don’t like the fact
that I make criticisms and talk about its top officials in this way.”
The
COO responded by saying Loftis’ claims are not only “ludicrous” and “not
substantiated” but also “probably untrue.”
“We’re
not about politics,” Ryberg said. “We’re moving forward, away from petty distractions.
We’re going to spend a good deal of time educating stakeholders and legislators
about operational challenges.”
Preliminary
hearings for the $1.2 million in-house management request are scheduled
throughout December. The proposal will move into House and Senate committees in
January and March of next year, perhaps raising the question: Can half of a
billion dollars buy cooperation among politicians?
—Leanna Orr & Sage Um