The New York Times, 6/8/15.
For years, the California Public Employees’ Retirement System, the country’s biggest state pension fund, paid Wall Street billions of dollars to help finance the retirement plans of teachers, firefighters, police and other state employees.
Now Calpers, which has just more than $300 billion of assets under management, plans to cut back drastically on those fees by severing its ties with half of the external investment managers of its funds, according to Ted Eliopoulos, the chief investment officer.
The decision is expected to send ripples through the investment management industry, giving some Wall Street firms a bigger piece of Calpers’s assets to invest while other firms — including some private equity, real estate and global equity funds — could be cut from the portfolio as soon as next month.
Calpers, which decided last year to liquidate $4 billion in hedge fund investments, has moved in recent years to simplify a portfolio that has become complex and expensive as it faces more difficult times ahead. This year, the fund will begin to make more payments to retirees than it receives from its investments. And by 2030, it could be left with a $10 billion shortfall between payments and the total amount of contributions from active workers and income from investments, Calpers said in a presentation in May.
“Calpers is taking the next step in what we see as a multiyear effort to reduce risk, cost and complexity so that we can deliver the investment returns that are necessary to meet our obligations,” Mr. Eliopoulos said in a call with reporters.
Eliminating some external managers will help Calpers shore up its investments by reducing fees. Last year, it paid $1.6 billion in management fees, $400 million of which was a one-time payment for its real estate managers, a Calpers spokesman said.
Other pension funds that are struggling to meet promised benefits to government workers have begun to focus on fees, too. Despite a bull market for the last several years, many state and municipal pension funds have not received large enough returns on their investments and are now faced with having too few assets to cover future costs.
“The biggest problems facing pension funds are twofold,” said David Crane, a lecturer in public policy at Stanford University and a former special adviser to Gov. Arnold Schwarzenegger. “One is earning enough to make up for their failure to earn what they said they would earn in the past, and two is making enough in this environment to pay for new promises.”
For pension plans across the country, the issue has become political as well as financial as taxpayers are increasingly being asked to pay for public pension shortfalls. “The more that is being paid to the asset managers, the less is available for public services,” Mr. Crane said.
In Pennsylvania, where the state is looking at a $50 billion hole in its pension fund, Gov. Tom Wolf recently called for a new approach to investing the state pension funds and urged the state to question how it had ended up with billions of dollars of debt.
“For example, why are we paying Wall Street managers hundreds of millions of dollars to manage our pension fund?” Mr. Wolf said at a budget address in March.
In New York City, Comptroller Scott M. Stringer has voiced similar concerns. The city’s five pension funds have paid more than $2 billion in fees over the last decade, outpacing the returns those funds made during the same period, according to a study commissioned this year.
“We need to demand more value from Wall Street when they invest the hard-earned pension dollars of our workers, because right now money managers are being paid exorbitant fees even when they fail to meet baseline targets,” Mr. Stringer said in a statement in April.
Calpers is a leader and example within the $3.8 trillion public pension community in the United States because of its size and its early adoption of sophisticated investment strategies. The fund oversees the retirement funds of more than 1.6 million public employees, including teachers, police officers and firefighters.
Since the financial crisis, when the value of their assets was decimated by losses, pension funds have moved more aggressively into private equity and hedge fund strategies, lured by the promise of high returns even in years when the broader market is down. But returns after the fees — which typically follow a “2 and 20” model in which investors pay an annual management fee of 2 percent of assets under management and 20 percent of returns — have been disappointing in more recent years.
The Securities and Exchange Commission has increased its scrutiny of private equity firms and how they value their assets and charge fees. The agency has found fault with more than half of the firms it has examined, raising questions about violations of law.
Calpers will inform its investment board this month about its plans to reduce the number of external managers to 100 from 212. As part of the move, Calpers will reduce the number of private equity firms to 30 from 98, giving the remaining managers $30 billion to manage. Calpers invests in some of the biggest and best known private equity firms in the world, including Blackstone, TPG, Carlyle and Kohlberg Kravis Roberts.
In addition, just 15 of the current 51 real estate managers will continue to invest the fund’s $26 billion real estate portfolio. And Calpers will eliminate 24 managers from its general equities portfolio, leaving 20 firms to invest $24 billion.
The Wall Street Journal first reported the news about Calpers’s decision.
Donald Boyd, a senior fellow at the Rockefeller Institute of Government, called the move to reduce fees wise. “It is an example of the squeeze they face to try to meet what in many cases might be unreasonable return expectations,” Mr. Boyd said.
“A little bit of fee reduction will certainly help,” he added. “But it is not enough.”