Friday, February 7, 2014

What We Need to Know: Public Pensions

What We Need to Know: Public Pensions

After writing numerous posts about the financial condition of the North Carolina pension plan and trying to rebut the need for a “forensic” investigation of the pension’s assets, I’ve been asked by a few readers to outline what I think a public pension plan should disclose about its money managers.  I’ve also been asked if pensions should make detailed disclosures of their fees.  Those of my readers who aren’t in the money management business may find this discussion boring or even opaque.  However, disclosure of pertinent data would make it far easier to assess the health of public pensions.

As I’ve thought about it, the question of fees is a bit of a red herring.   While the amount of fees paid by most pension plans creates sensational headlines, fees alone don’t tell us much about how well a pension’s assets are performing.  Moreover, management fees alone don’t capture all the expenses incurred by a pension’s investments.  In order to evaluate whether the pension is getting value from its money managers, the fees have to be connected to investment performance.

Sketchbook #4 (2001)
If public pensions only disclosed the following two items, we’d have a very good idea about whether the assets are being well managed or not.

·      The asset value and gross and net performance for each manager and asset class for one, three, five, and ten-year performance, as well as performance since inception of the mandate, along with the relevant benchmark.

·      The commitments, drawn capital, realized and unrealized returns of every private equity and real estate investment fund and separate account.

If pension plans disclosed their gross and net performance, we’d know exactly how much it costs to generate returns, because the difference between those two figures captures all fees incurred by a pension, including carried interest or incentive fees.  It would be relatively easy to figure out where capital is being wisely and efficiently deployed, and where it is being poorly positioned.

The second set of items is needed in order to evaluate the true exposure to and performance of private equity and real estate.  In these two asset classes, pension plans make long-term commitments to make capital available as managers call for it in order to fund acquisitions.  In other words, pension plans have commitments to fund these asset classes that will only be invested in the future.  If these future commitments aren’t well managed, a pension plan may become overexposed to a particular asset class.  By separating the realized and unrealized return, the public is able to determine how much of pension’s performance is based on assets that have actually been sold, and how much is based on manager estimates.  Manager estimates are notoriously unreliable. 

Wouldn’t all of this disclosure hurt pension plans?  Wouldn’t it make money managers less willing to offer their services to public pensions?  Not at all.  The  most powerful and successful money managers in the world disclose this information.  As public companies, Apollo Global Management, Blackstone, Carlyle, and KKR disclose this type of information every quarter. Mutual funds routinely release this information.  Public pension plans should as well.

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