Monday, April 21, 2014

Transparency Through Slightly Frosted Glass: CalPERS Investment Expenses

Transparency Through Slightly Frosted Glass: CalPERS Investment Expenses

For decades CalPERS has been a leader in public pension investing, governance, and disclosure. With $288 billion in assets, CalPERS has the wherewithal to nudge the entire industry in a new direction when it begins to change its policies and practices.  In recent months they’ve been taking a detailed look at their expenses, especially for outside managers.    CalPERS Annual Report[1] for the year ending June 30, 2013 forms the basis for a cost analysis recently presented to the pension’s investment committee[2]. 

The broad conclusions of the report are just what you’d expect.  Managing assets internally is far cheaper than managing them externally.  Narrowing the number of external relationships and employing CalPERS’s considerable clout can drive down costs.  CalPERS direction is sound.  What surprised me was the weakness and untimeliness of their data.

CalPERS’s staff reported to the investment committee that the pension’s total costs in FY 2013 was $1.3 billion and came to 53.5 BPs.[3] External managers constituted $1.2 billion of that cost.  It sounds pretty comprehensive and complete until you start to get into the details, and details matter when you are trying to pare costs.

·      According to the tiny footnotes, the external management cost of $1.3 billion does not include underlying fund of funds fees, but for some reason the 53.5 BP includes an estimate of those fees.  If you aren’t confused yet, the annual report states that the total costs were 51 BPs because the annual report excludes fund of fund fees.[4]

·      Moreover, for some reason the staff presentation to the investment committee dropped $61 million in miscellaneous expenses[5] or roughly 5% of the fees listed in the annual report. If these expenses had been included, the total would have risen to just under 56 BPs.

·      There is also a large and unexplained item missing in CalPERS’s analysis.  While incentive payments and carried interest are included for real estate and hedge funds, they are excluded for private equity.  CalPERS paid $476 million in management fees to private equity managers.[6]  Unless the pension’s private equity managers were incredibly unsuccessful, there are at least a couple of hundred million dollars in fees excluded from the analysis.  I’m not sure how you do an analysis that includes carried interest for only certain asset classes.  In any event, total expenses are probably 60 BPs or 65 BPs, if PE carried interest were included.

·      There’s yet another problem with the presentation.  According to the footnotes, the expenses are for calendar 2012, not FY 2013: there’s a six-month difference.[7]  However, the average assets used to calculate the fees in basis points are for the end of the fiscal year.   The average calendar year assets were $225 billion, while average fiscal year assets were $270 billion.[8]  If a pension plan is trying to look at its fees as a percentage of assets under management, the plan must use the same time period.  Using the proper measure for assets under management would boost CalPERS’s fees closer to 75 BPs or even 80 BPs.

·      Irrespective of the omissions and miscalculations, the data is old. The investment committee met on April 14, 2014, and they are evaluating the cost effectiveness of the country’s largest public pension plan using data that is over a year old.

·      However, when it came time to showing how all these expenses are paying off in the form of performance, the staff presented the 2012 expense data in comparison to the performance of the fund as of the end of 2013.  See the chart[9].

Although investment policy is the key driver of pension assets, costs are an important long-term consideration.  Thus, CalPERS’s cost analysis is a worthwhile exercise.   These exercises must be carried out accurately and with timely data, since public pensions are underfunded and under attack.  Otherwise, they’ll simply be providing their critics with additional ammunition. 

[3] Item06a-01 at page 8
[4] Annual Report at page 117
[5] Ibid at page 117
[6] Ibid at page 115
[7] Ibid, page 117, footnote 1

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