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Half a Billion in Fees: How Two US Public Pensions Spent It

New York City and South Carolina’s pension systems spent roughly the same amount on annual investment fees—and both are under fire for it.

(December 2, 2013) – What will $500 million in asset management fees buy? A heck of a lot of trouble, judging by recent controversy surrounding two US public pension funds’ investment expenses.

New York City and South Carolina’s retirement systems each shelled out just under half of a billion dollars to asset managers in the most recent fiscal year. Both public defined benefit schemes outsource effectively all of their assets to external investment firms. Allocations to alternatives are by far the most expensive part of each system’s portfolio.

The catch? Between its five pension funds, New York City’s assets total $144 billion. South Carolina spends roughly the same on a $27 billion portfolio.

Furthermore, in the 2013 fiscal year, New York City’s funds returned 12.12% and South Carolina’s gained a net 9.9%. The former has likewise outpaced its southern peer over three- and five- year performance periods.  

But both organizations have come under fire in recent weeks for their half-billion investment expense tabs. Here is an in-depth look as to why, and what those in charge are doing about it.

 

New York City Retirement Systems ($144 billion AUM)

“Wall Street Fees Paid by NYC’s Pension Funds Climb 28%,” announced a Bloomberg headline on November 22, following the release of the comptroller’s annual report for fiscal 2013. It’s the story no PR person wants to wake up to.

New York City’s five massive retirement funds have long been characterized as a governance nightmare, including by their most recent CIO Larry Schloss and by this publication. As with South Carolina’s state system, New York City outsources all of its asset management, leading to higher fees than it might otherwise incur. 

“Of the top 10 US public pension funds—NYC is number five—we’re one of two outsourcing everything,” Schloss told aiCIO last year. (The other fund is Washington State’s.) “It hasn’t at all changed in 70 years. We’ve gone to the moon and invented the internet in 70 years. You’d like to think you can change this, especially with the talent present here in the world’s financial capital.” 

Near the end of his tenure, Schloss put forth a proposal to start the insourcing process. It hasn’t gained traction since then, although his estimated timeline for full implementation was an astonishing 10 to 20 years. Until then, the New York City pension system’s costs of doing business land in the pockets of Wall Street-types. Based on the latest fee figures and the official reasoning behind them, those costs will likely continue to mount. 

The 28% figure cited by Bloomberg is accurate: New York City’s pension funds spent $472.5 million on investment fees in the 2013 fiscal year, and $370.2 million the year prior. Add in the defined contribution plans and health benefit funds, and the recent payout amounts to $499 million, which is $105 million higher than the previous year. But nearly half of the rise in management expenses can be attributed to growth in the pool of assets needing to be managed. The funds closed FY2013 with a collective $137.4 billion, and 2012 with $122.1 billion—a rise of 13%.

When reached by aiCIO, a spokesperson for the Comptroller’s Office was audibly frustrated at the “rising fees, stagnant performance” angle prevailing in press reports on the data. The comptroller, who is responsible for the retirement funds, pinned the jump in fees on changing asset allocation as opposed to a Wall Street feeding frenzy. 

“It’s misleading to cherry pick one year and compare a rise in fees with the rate of return,” the office said in a statement. “Fees rose in FY2013 consistent with the recent expansion into alternative asset classes that diversify the portfolio against events like the stock market collapse in 2008. By making these alternative investments, the funds have helped reduce the risk in the portfolio for both pensioners and taxpayers, particularly in times of stock market distress… The fact is that many alternative investments, such as private equity and real estate, have front loaded fees and don’t generate returns for several years.”

Allocations to alternatives have risen over the past few years, although not by a huge margin according to the latest available data. Taken together, private equity, private real estate, and hedge funds amounted to 11.2% of the systems’ portfolio as of August 31, 2013. A year prior, that portion was 11.1% and in 2011 it was 9.7%. Change comes slowly to New York City’s retirement funds.

From a fee perspective, that’s a good thing. The city’s biggest fund, the $47 billion New York City Employees’ Retirement System, is also the largest municipal pension scheme in the United States. During the 2012 fiscal year, alternatives accounted for 15.8% of the portfolio but 63.5% of its total fee spending. 

There is a consensus among consultants and alternative managers alike that fees have fallen overall since the financial crisis. This trend in alternatives, like New York City’s rebalancing towards the asset classes, is operating in the margins. South Carolina’s $11 billon alternatives program, representing nearly half of its total portfolio, is not. 

 

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