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Pension funds

CalPERS hampered by fee complications

Theodore Eliopoulos wants to trim the number of external managers by more than half.

Lack of data hurting effort to cut managers and costs

CalPERS officials, embarking on a major project to cut the fund's roster of external money managers and reduce fees, are blindfolded because they can't track what is being paid to private equity firms, the most fee-intensive group.

The plan announced last week by Theodore Eliopoulos, chief investment officer of the $304.1 billion California Public Employees' Retirement System, Sacramento, is aimed at lowering fees, risk and complexity by reducing the number of external managers to about 100 from 212. For the year ended June 30, 2014, CalPERS paid more than $1.6 billion in management fees to external managers, with a huge chunk, $441 million, going to private equity firms.

That $441 million is the usual 1% to 2% base management fee that CalPERS is charged. It does not include carried interest or performance fees, which J.J. Jelincic, a CalPERS board member, estimates could add another $600 million to $900 million.

If Mr. Jelincic is right, CalPERS paid as much as $2.5 billion in fees to money managers in the last fiscal year.

While CalPERS officials won't comment on Mr. Jelincic's numbers, they concede they have been unable to determine just how much they do pay.

CalPERS fees
All figures are in millions. Data are as of June 30, 2014, unless otherwise indicated.
Asset classMarket valueManagement
Total fees
Global equity$153,639.2$71.6$77.0$148.6
Global debt securities$72,465.0$2.5$4.2$6.7
Real assets$29,580.4$206.3$660.1$866.4
Private equity*$31,512.6$439.8N/A$439.8
Absolute return$4,522.3$61.5$68.4$129.9
*Private equity data are for the year ended Dec. 31, 2013. Carried interest was not disclosed.
Source: Company reports

For external money managers, CalPERS officials are not planning major reductions in the more than $100 billion they allocate to them. Instead, they hope to assign bigger mandates to fewer managers, focusing on top performers and hoping to get fee concessions.

Fund officials also will create a $7 billion transition program that will allow emerging managers with smaller allocations — some as little as $8 million — to get more money from the system, perhaps hundreds of millions of dollars, over a period of years.

But cost saving might remain elusive. Interviews with CalPERS officials, along with meeting videos and CalPERS documents, show officials don't know what the fund pays in carried interest to private equity firms when they meet their performance hurdles. That fact was acknowledged by Mr. Eliopoulos in a June 8 conference call with reporters. He said he believes having a smaller number of private equity firms would allow CalPERS to capture the performance data.

Long been a leader

In a statement to Pensions & Investments, CalPERS spokesman Joe DeAnda said the pension fund has long been a leader in advocating for fee economies and transparency, including in private equity. “A necessary element in that effort is additional disclosure and reporting from the general partners managing the funds.” He said CalPERS officials have been talking to officials at the private equity firms to help improve disclosure. He did not offer specifics.

The lack of information on fees was brought up during an April 13 investment committee meeting. In a video recording of the meeting, Wylie Tollette, chief administrative investment officer, said CalPERS didn't track private equity performance fees because “profit sharing in the private equity market, in fact the whole private equity industry, (is) embedded in the return.”

“It's not explicitly discussed or accounted for. We can't track it today.”

With more than $40 billion in commitments, CalPERS runs one of the largest private equity programs in the world. For the five-year period ended April 30, CalPERS' private equity holdings earned an annualized 14.4%, making it the pension fund's best-performing large asset class.

The problem, says board member Mr. Jelincic, is during the asset distribution process, when private equity managers deduct their portion of the carry — the profit split between the manager or general partner and limited partners like CalPERS. The issue arises because there is no information on what deductions were taken and how the ultimate fee charged to CalPERS was determined, he said.

He said that makes it impossible to determine if the manager is keeping too much from the sale of portfolio companies and could potentially result in CalPERS paying higher fees because it is not getting the right payout.

“It's like selling your house and having them say, "here are your proceeds,'” he said. ”But we're not saying how much we sold the house for, how much we charged you in commission, how much we charged you in fees.”

CalPERS staffers have said they have been successful in reducing typical management fees paid to private equity managers to 1% from 2% and performance fees to 10% from 20%. CalPERS typically pays the performance or carried interest fee after a private equity fund is able to pay a minimum profit from the sale of portfolio companies, called a hurdle rate, typically 5% to 8%, say CalPERS sources.

At the April 13 investment committee meeting, Mr. Tollette said CalPERS will be requiring additional disclosures by private equity managers to track incentive fees. He said CalPERS is testing a new private equity computer reporting system that can track and capture the data managers provide.

CalPERS statistics for the fiscal year ended June 30, 2014, show that in addition to the $441 million in base fees paid to private equity managers, the pension fund also paid $76 million to global equity managers and $206 million in base fees to real asset managers, including real estate.

The real assets performance fees amounted to another $261 million (excluding a one-time payment of $300 million due to a change in accounting rules). Mr. DeAnda said CalPERS officials would be unavailable for additional comment on the private equity carry fees.

Part of the problem is the lack of an industry standard for how private equity managers calculate performance fees, said Michael S. Falk, a partner at Focus Consulting Group, Long Grove, Ill., a money manager consultant.

“It's not like going to the store knowing the price for buying a loaf of bread,” he said.

Mr. Eliopoulos' manager reduction plan will have its biggest effect on the private equity portfolio. As part of the effort to cut poorly performing managers and trim fees, the number of direct relationships is expected to drop over the next decade to about 30 from 100 as funds expire or CalPERS' stakes in the funds are sold on the secondary market.

CalPERS also has more than 200 manager relationships within private equity funds of funds, some of which will be eliminated. Those that are part of emerging manager funds of funds will be retained if CalPERS officials deem performance to be acceptable.

Mr. Jelincic said he wants the matter of private equity carry fees discussed at open sessions of investment committee meetings. But video recordings of CalPERS investment committee meetings over the last year show that when Mr. Jelincic has brought up the topic, investment staff has said fees should be discussed in closed sessions.

Problem is universal

One source, who requested anonymity because he is not authorized to give an interview, said the problem of getting detailed carry information is universal and dates to the founding of the private equity industry.

He said the carry information provided by private equity managers is so slim that CalPERS and other asset owners can't ever tell through manager financial statements how the sale of a particular portfolio company from a buyout fund affects fees they receive.

The official said he believes private equity firms will be forced to provide more detailed fee information in the future, partly because of general pressure by the Securities and Exchange Commission.

The SEC scrutiny doesn't necessary apply to carry fees, he said, but to fees private equity managers charge portfolio companies. Still, he said, the attention has put managers under the gun.

This article originally appeared in the June 15, 2015 print issue as, "CalPERS hampered by fee complications".