Warren Buffet Tells Pensions and Endowments to Cut Management Fees

Warren Buffett has a word of advice for pension funds and endowments: cut out those high-fee “helpers,” namely consultants, outside managers, and others he deems a drag on returns.

In Berkshire Hathaway’s latest annual letter, Buffett describes US growth over the last 77 years. Why 77 years? That refers to when he bought his first stock: three shares of Cities Service for $114.75. And he did a little math regarding public pension funds and college endowments.

“If my $114.75 had been invested in a no-fee S&P 500 index fund, and all dividends had been reinvested, my stake would have grown to be worth (pre-taxes) $606,811 on January 31, 2019 (the latest data available before the printing of this letter),” he wrote. “That is a gain of 5,288 for 1.”

Buffett added that a $1 million investment by a tax-free institution such as a pension fund or college endowment would have grown to “about $5.3 billion.” But there’s a caveat:

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“Let me add one additional calculation that I believe will shock you: If that hypothetical institution had paid only 1% of assets annually to various ‘helpers,’ such as investment managers and consultants, its gain would have been cut in half, to $2.65 billion. That’s what happens over 77 years when the 11.8% annual return actually achieved by the S&P 500 is recalculated at a 10.8% rate.”

Management fees is an issue that institutions are regularly grappling with, as many money managers will either underperform the S&P or match it by investing in index funds. Managers typically demand a 1% cut (2% if they are a hedge fund) regardless of the result. Since a considerable amount of these public pension plans are vastly underfunded, such as Kentucky (31%) and Illinois (36%), these payouts can further hurt funding.

“In the public sector, you know, it’s a disaster,” Buffet said of the pension funding gap in an interview on CNBC’s Squawk Box.

State retirement funds and endowments have been debating on how to correct the issue of paying high fees to these managers, especially if they are putting the money into the S&P and essentially letting the markets do the work for them.

Some, such as the Canada Pension Plan Investment Board ($368.5 billion), internalize more of their staff and provide better compensation. Others, such as Britt Harris’ $45.3 billion University of Texas Investment Management Company (UTIMCO), utilize the “1 or 30” fee structure.

Harris’ approach, a play on the “2 and 20” hedge fund model, gives managers the option to take either a 1% management fee or a 30% performance cut. The model was introduced during his time at the Teacher Retirement System of Texas as a way to deal with underperforming hedges, which the $154 billion pension plan still uses this day.

Harris has not only taken that structure to the endowment, but also adopts it for private equity managers.

Maybe Buffett would approve.

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Tags: Berkshire Hathaway, Britt Harris, Endowments, fees, Pension, UTIMCO, Warren Buffett

Hedge fund titan Ray Dalio has again weighed in on monetary policy, this time with a more upbeat tone: He no longer thinks a recession is around the corner.

The reason: Federal Reserve Chairman Jerome Powell’s recent signal, in the face of late-2018’s market selloff, that he would go slower on hiking interest rates. Dalio of Bridgewater Associates reduced his pre-2020 election recession odds to roughly 35%, from 50%. The Fed may well not raise rates at all in 2019, so Dalio can sleep a little easier.

“Because the markets weakened and Fed officials now see that the economy and inflation are weak, there has been a shift to an easier stance by the Fed,” he said in a LinkedIn post. “Similarly, because of weaker markets, economies, and inflation rates in other countries, other central banks have also become more inclined to ease, though they have less room to ease than the Fed.”

However, the founder and co-chief investment officer of the world’s largest hedge fund is still troubled by economic weakness that central banks may not be able to fix. The continued slowing of global growth doesn’t help, nor do domestic and international conflicts such as the US and China’s trade war and Brexit’s looming deadline.

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Dalio said the Fed can probably manage the “big sag” economists are predicting, but things aren’t so rosy on the other side of the world. The situation, he said, was “more concerning” as a result.

“In Europe, the ECB appears unable and/or unwilling to adequately ease (because of politics and structural issues) while circumstances (the sag in growth and sub-target inflation) warrant an easing,” he said, predicting “chronic slow growth” if populist political forces increase.

Source: LinkedIn

“In Japan, we also see low growth and low inflation with slightly more room to do QE and better yield curve controls than Europe has (though the marginal effects of these will be limited),” said Dalio.

Lastly, Bridgewater’s founder said, although China’s government is doing its best to offset its growth slump with more fiscal and monetary stimulation, it’s not enough to re-normalize growth.

“In other emerging countries, we are generally also seeing weaker growth and inflation, and the increased ability to ease monetary policy, but not yet enough easing to cause recoveries to desired levels,” he said.

Source: LinkedIn

Bridgewater Associates has $160 billion in assets under management.

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Tags: Bridgewater Associates, Economy, Federal Reserve, Hedge Funds, Ray Dalio