Public plans cutting money management fees

U.S. public pension fund officials are increasingly asking their external investment managers for fee concessions as part of an effort to cut operating costs.

Some of the concessions are taking place behind the scenes, as in the case of the $74.4 billion Washington State Investment Board. Others are coming as the result of public audits, such as that of the $68.7.billion North Carolina Retirement Systems, that found some manager fees were higher than the norm.

The most visible fee reduction efforts are those of the nation's two largest public pension systems, the $204.4 billion California Public Employees' Retirement System and the $129.7 billion California State Teacher's Retirement System.

CalPERS officials said they have saved $99 million in fees in the past six months across asset classes as the result of fee reductions. The largest cuts, totaling $56 million, were made by 10 hedge fund managers, said CalPERS Chief Investment Officer Joseph Dear.

“We have reduced the number of our hedge fund relationships but have obtained better fees on commitments,” said Mr. Dear in an e-mail response to questions.

The remaining cuts came from 11 global equity managers, 17 private equity managers, two fixed-income managers and 13 real estate managers, said CalPERS spokesman Clark McKinley.

Mr. McKinley said that in the next few months, Sacramento-based CalPERS will be looking for additional fee cuts from other real estate and private equity managers.

At West Sacramento-based CalSTRS, officials said they have been reaching a high level of success as they push for an average 15% across-the-board cut for all external investment managers. CalSTRS spends $140 million annually on money management fees, its biggest administrative expense.

Part of the reason for the success might be that CalSTRS officials aren't taking no for an answer.

“Our approach is that we will achieve lower fees one way or another,” said Trish Taniguchi, director of global equities.

“One manager said, "We don't negotiate fees,' so we reduced our investment with them by 30(%) to 40%,” she said.

Ms. Taniguchi would not identify the manager. But she said the manager, whose fee is tied to the amount managed for CalSTRS, is now receiving a fee that is lower than it would have received had it agreed to the initial reduction request.

Other investment managers have appeared to see the light.

Ms. Taniguchi said CalSTRS officials have reached some degree of agreement on fee reductions with 18 of 30 global equity managers since the fee-cut program began a year ago. Negotiations continue with the remaining 12 managers, she said.

CalSTRS has solicited input from the managers as to how the fee reductions should take place, she said. Some managers have proposed, and CalSTRS has agreed to, a performance incentive system that pays minimum fees in years of poor performance and increased compensation in years in which portfolios outperform their benchmark.

CIO Christopher Ailman told the CalSTRS board at its monthly meeting on July 9 that significant fee reductions were being achieved across asset classes. As of last week, a detailed summary of the cuts was not yet available.

But reductions achieved in global equity manager fees will be significant because it is CalSTRS' largest asset class. Global equities comprise $67.5 billion, or more than 50%, of the system's total assets, according to financial statements.

While CalSTRS and CalPERS officials have discussed cost reductions openly at public board meetings, officials at other funds have not.

“We have had some concessions, some fee reductions,” said Theresa Whitmarsh, executive director of the Washington State Investment Board, Olympia.

But Ms. Whitmarsh would not go into detail, saying the investment board has a policy of not publicly discussing the issue.

Indeed, approaching investment managers to renegotiate an existing contract is a delicate matter, especially as plan executives try to keep winning managers in their stable.

The CIO of one major state plan, who asked not to be identified because he has yet to discuss the matter with his board, said he is working on a short-term solution to the fee issue asking its external money managers to agree to temporary cuts lasting at least a year.

In North Carolina, fee reductions began after State Treasurer Janet Cowell hired consultant Ennis Knupp & Associates Inc. to do a full fiduciary review of the Raleigh-based systems.

The result, announced on June 17, found 36 of 41 public equity managers charged fees that were significantly lower than average fees for comparable managers. But six strategies overseen by five managers ranked above the median in terms of competitive fees.

Ms. Cowell said in an interview that North Carolina officials were able to negotiate fee reductions totaling $2.4 million with the five managers: Numeric Investors LLC; Longview Partners LP; Relational Investors LLC; TimesSquare Capital Management LLC; and Turner Investment Partners Inc.

The biggest cost savings came from Relational Investors. Relational will keep its 1.5% management fee on the first $300 million it manages for North Carolina, but will reduce the fee to 1% for anything above $300 million. Relational will still be eligible to earn a 20% incentive fee for amounts earned over the benchmark, but it now will have to outperform that benchmark for three consecutive years to get its full fee.

The North Carolina retirement plans have $574.6 million invested with Relational, and the cost savings estimated by the treasurer's office amounted to $1.2 million.

Ms. Cowell said that as pension plans have struggled following the global economic meltdown, there has been more interest in plan expenses and what can be done to reduce them. “People are asking a lot of questions about fees,” she said.

Ralph Whitworth, founder and principal of Relational Investors, said it has become common during the past year for pension officials to seek reductions.

He said Relational has applied fee reductions given to North Carolina and CalPERS to other clients with similar-size mandates because of “favored nation” clauses in their contracts. Those provisions require Relational to match fees given to one client to others with similar investments. Mr. Whitworth declined to say how many clients have been given fee breaks.

He also said the company's fees were below average when compared with similar managers — those specializing in buying stock in companies with good corporate governance practices.

But Mr. Whitworth said Relational has agreed to fee cuts in an effort to be a good investment partner. “There have been major changes in our industry, market conditions have changed,” he said. “These are valuable relationships. We want to share in the efforts to lower costs.”

Officials at Turner Investments declined to comment. Officials at Numeric, Longview and TimesSquare did not return phone calls.

There still is plenty of debate over whether fee cuts should occur. For example, George Hopkins, director of the $10.2 billion Arkansas Teacher Retirement System, Little Rock, said he doesn't believe fund officials have the right to change existing contracts.

Mr. Hopkins said officials at his fund are thinking more strategically when it comes to new mandates and fees. He said managers often will reduce fees for larger mandates, so the pension system now assesses whether going with fewer managers for a particular asset class is the better route.

David Holmes, partner at Eager, Davis & Holmes LLC, a consultant to money managers in Louisville, Ky., said managers have been a lot more willing to cut fees for existing clients because new mandates have been hard to come by in the past several years.

“When demand is down, there is more of a proclivity for investment managers to be a bit soft on fees,” he said.

But Mr. Holmes believes the window for fee speculation will be shrinking in coming months as more pension funds launch more manager searches. “Demand is picking up,” he said.

However, he says, the largest pension plans still will be able to have the most leverage at getting discounted fees because their mandates are larger.

Ultimately, Mr. Holmes said, managers with the best results will be able to earn the best fees.

“Investors are willing to pay more for good investment performance,” he said.