Wednesday, September 16, 2015

Kentucky Retirement System is Still Translucent and Off Course

Kentucky Retirement System is Still Translucent and Off Course

About a year ago I wrote about the poor record of performance and disclosure at the Kentucky Retirement System (“The Art of Translucency” August 25, 2014[1]).  It took KRS twelve months, but they’ve finally gotten a bit more transparent about the fees they are incurring.  In fiscal 2014 KRS reported $46.3 million in fees, which was ridiculously low.  Why?  KRS didn’t include the management fees paid to private equity managers.  They simply chose to hide them. This year, KRS has revealed that the fees for 2015 were $80.4 million and has intimated that they paid a similar amount in 2014.[2]  The KRS trustees don’t deserve any credit for taking this step.  All they’ve done is reached the level of disclosure of the average pension plan.

The trustees also retained CEM benchmarking to evaluate the performance and fees of KRS’s investment program in the past five years.[3]  In exchange for its big bet on alternative investments, KRS achieved an 8.2% return versus 9.8% for the median public pension plan and 9.2% against its peers. KRS’s strategies and managers cost the plan 1% in net value per year, and its average management fee was 0.82% versus benchmark costs of 0.75%.  In short, they paid higher than average fees and got substantially poorer performance.

I think there are three take-aways from KRS’s recent reports.  First, KRS has only achieved a small degree of additional transparency.  Like any other pension plan seriously committed to alternatives, KRS incurs all sorts of hidden fees (carried interest, monitoring fees, etc.).  KRS isn’t disclosing any of those numbers, which would probably double the pension’s reported fees.

Second, KRS didn’t need the CEM report to tell them they were underperforming, while incurring above average expenses.  The trustees need only have looked at publicly available data and their own internal reports.  However, trustees have a long history of hiring consultants to tell them what they either already know or should know if they were doing their jobs.

Third, the CEM report reveals the entirely predictable point that the average pension plan’s asset allocation and manager selection do not add any value whatsoever.  Obviously, some pension plans add a bit of value in a given year and others detract value, but on average all the asset allocation strategies and manager searches yield nothing, unless, of course, you are a money manager or consultant.  The winners and losers aren’t the by-product of skill or a lack of skill.  Rather, adding or subtracting value is merely a random phenomenon.

Thus Kentucky and every other pension plan would be best served by resisting the marketing pitches of the alternative investment community, driving down investment expenses, and negotiating hard on fees. 


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