Overseers of government pension funds are taking a closer look at the fees they're paying to hedge funds, private equity investors, real estate funds and other so-called "alternative" investments -- and many of them don't like what they are seeing.
The California Public Employees Retirement System, the largest U.S. public employee pension fund, recently disclosed it has paid these investment advisers $3.4 billion since 1990 and intends to sever ties with the worst performers to reduce the outflow of fees. New Jersey's Investment Council plans to issue a report soon that similarly details the fees it has paid over the past five years for alternative investments and the corresponding performance it has seen, according to Pensions & Investments. New York City Comptroller Scott Stringer recently noted that money managers had fallen $2.5 billion short of their benchmarks over the past decade for the city's public pension funds. He vowed to drop investment managers from the pension portfolios he oversees if they failed to adequately disclose their fees.
"In general, private equity is a high-fee asset class because there are a lot of resources that are needed," Anne Anquillare, CEO of private fund administrator PEF Services, told CBS MoneyWatch. "You certainly wouldn't want all of your money in private equity, but if you do it right the top quartile of private equity funds has some amazing performances."
U.S. public pensions have about $3 trillion in assets and fund the retirements of millions of current and former workers, so anything that's connected with them has huge ramifications for both the markets and the economy. Alternative investments now account for about 25 percent of invested assets in these funds compared with 11 percent in 2006, according to data from the Pew Charitable Trusts. They now pay about $10 billion in fees, a number that more than doubled in that same time period.
"The recent push toward universal transparency is universally good," Josh McGee, a vice president with at the Laura and John Arnold Foundation, said of the fees for alternative investments. "These assets are meant to be managed for the sole benefit of plan members."
Why are state and local governments moving into these riskier investments at a time when they are putting less money into safer investments like U.S. Treasury bills? Because the returns can be better. This has raised concerns in some state capitals and city halls about whether public pension funds are becoming too reliant on complicated and risky investments. This can be especially difficult with private equity investments, which can take years to pay out and are difficult to value. Meanwhile, it's not always clear to plan members how secure their retirements may be since many of the public plans have been underfunded for years.
"Some investment management fees are not explicitly identified in public financial reports for some plans -- including performance fees or carried interest on private equity investments -- making it difficult to calculate the exact amount of fees paid and highlighting the need for more consistent disclosure," Gregory Mennis, director of retirement systems for the Pew Charitable Trusts, said in an email.
The issue of carried interest concerns the preferential tax treatment that the private equity industry enjoys, a benefit that presidential candidates from Hillary Clinton and Bernie Sanders to Donald Trump have denounced as being unfair to middle-class taxpayers. It seems likely to come again in the 2016 election.