When it comes to high private equity fees, it takes two to
Public pensions’ lack of strong governance is at least partly to blame
for poor negotiation of private equity fund terms: So reads the conclusion of a strongly worded report from
Paul Rose, professor of business law at Ohio State University’s Moritz College
“Pension funds may pay many millions for external managers to access investments that could reasonably be made in house.”“As strong returns have become harder to achieve, some
pension funds find themselves in the difficult position of having to expose
their lack of diligence in negotiating for more appropriate fee arrangements,”
He criticized the politicization of pension funds, which he
argued had led to states reducing contributions—and the short-term cost to
taxpayers—during periods of strong market performance. Having failed to make
hay while the sun was shining, they then failed to increase contributions when
investment returns declined.
“As a result, funds have to seek alpha to make up the
difference, and have had to turn to private funds to make up the difference,”
Rose wrote. “This creates a sellers’ market for private fund managers, in which
they are able to charge higher fees to desperate pensions.”
In a separate
article published in November, Rose and the US Treasury department’s Jason Seligman had argued that the lower a public pension’s funding level, the
higher its exposure to alternative asset classes was likely to be.
A lack of professionalism and inability (or unwillingness)
to pay market rates for qualified staff can also hamper pensions’ ability to
drive down fees, Rose said.
“As a result, instead of paying in the hundreds of
thousands for qualified market professionals, pension funds may pay many
millions for external managers to access investments that could reasonably be
made in house,” he added.
Public pensions are also not held to account in the same way
as their private
sector peers, Rose claimed. In part, this is due to damage to defined
benefit pensions being hard to prove—even a concrete loss does not change the
promises made to members.
In addition, many state retirement systems are legally
classified as “arms of the state,” Rose said—citing a 2005 case involving the
Michigan Judges Retirement System—and as such are subject to sovereign
“The consequence of the few rulings on fiduciary duties is
that… there is no practical way for pension fund beneficiaries to remedy the
breach of those duties,” Rose said. He called for legislation to allow pension
fund members to take legal action against perceived breaches.
Earlier this year, Jon Grabel, CIO of the New Mexico Public
Employees Retirement Association, said accepting excessive fees was an “abdication”
of fiduciary duty. “We have a duty to make sure we’re getting our money’s
worth in pursuit of our mission, and when somebody says, ‘Just trust us,’ to
me, that’s a tell,” Grabel said.
Public funds should make immediate efforts to improve their
governance structures, Rose concluded, which would “help limit inappropriately
high private fund fees.”
Read Rose’s full article, “Public Fund
Governance and Private Fund Fees.”
Mexico CIO: Don’t ‘Pander’ to Asset Managers; The
Politics of Pay in Private Equity; SEC
Director Hails ‘Real Change’ on PE Fees