US pension plans may be paying more fees to their private equity managers than they realize, even for underperforming funds, according to research.
Ludovic Phalippou, a private equity specialist at Oxford University’s Saïd Business School, found investors often neglect to track carried interest—a portion of profits paid to managers—but also write similar checks to bad funds.
“If there are a few well performing funds and many badly performing funds then a lot of carried interest is paid despite poor performance,” the paper said. “In fact, carried interest may be more than 20% of the profits generated by a private equity program.”
That bill for America’s largest pension plan—the California Public Employees’ Retirement System (CalPERS)—came to about $5.3 billion over a period of 18 years, Phalippou calculated.
“If there are a few well performing funds and many badly performing funds then a lot of carried interest is paid despite poor performance.”This figure was some 18% of the $20 billion in profits from private equity funds invested into from 1991 to 2008.
Management fees are likely in the same ballpark, the author estimated, in addition to a plethora of “fees and expenses that are charged directly to the companies held by the funds.”
“These fees are hard to track, and expenses are yet more difficult to track,” Phalippou wrote.
In April, CalPERS admitted it didn’t know and couldn’t track all of the performance fees paid to its private equity managers. Shortly thereafter, the $300 billion fund launched an investigation to gather comprehensive fee and profit data on the program.
CalPERS has a $29 billion private equity portfolio—as of March 31—and said it plans to cut its manager roster by up to two-thirds. According to its annual review of the private equity program, the fund paid $455 million in manager fees for the 2014 fiscal year.
“What is an appropriate management fee?” CIO Ted Eliopoulos asked his investment committee Wednesday. “What level of profit-sharing adequately recognizes a manager’s skill and expertise and also fairly compensates the limited partner for assuming the risk? These are questions that deserve renewed attention and consideration.”
CalPERS is not the only pension failing to track its fees and carried interest costs, Phalippou argued.
He estimated the Washington State Investment Board ($106.8 billion in total assets) would have paid an estimated $4.4 billion, or 19.3% of profits, in carried interest, for its private equity funds of vintage years 2008 and earlier.
Likewise, the $70 billion Oregon Public Employees Retirement Fund’s performance-based fees would amount to roughly $4 billion, or 18.6% of profits.
Read the full paper: “A Note on Carried Interest in Private Equity”.
Related: Start Soul Searching, CalPERS CIO Tells Private Equity