By Susan Barreto
It’s been more than a year since Hank Morris
received a four-year prison sentence for his role in the
placement agent scandal that brought to light
'pay-to-play’ practices within the New York State
Comptroller’s office, which oversees the
state’s pension system.
Since the use of placement agents (a practice where managers
pay politically connected agents to help them win mandates)
came to light in New York roughly five years ago, it seems that
more public pensions have focused on what they are actually
paying their managers in both management and incentive fees.
Some of this action is due to plummeting hedge fund returns and
a willingness on the part of some firms to negotiate. In other
instances, it is a case of pension investment staffers
wondering what they were really paying for all these years
– performance or marketing.
In New York, for instance, a recent report from the
Independent Democratic Conference (IDC) found the New York
State Common Retirement Fund’s investment
portfolio has actually reported negative growth since 2007,
while management and performance fees have risen by 160%. The
research paper adds that in 2008, the New York pension system
paid $272 million in fees. The following year, when the market
crashed and the pension fund lost $45 billion, the pension fund
paid even more in fees.
Hedge funds, which were at the centre of the 'pay to
play’ scandal, are the main culprit for the rising
fees in New York, say critics. The IDC found that in 2010 when
hedge funds underperformed equities, the pension fund paid $50
million in fees. Then in 2011, when hedge funds delivered the
worst returns of any asset class, the pension fund paid the
most it ever paid to hedge fund managers – roughly
$123 million. The public-interest group has plans to draft
legislation requiring public, online disclosure of all
management and performance fee arrangements.
Comptroller Thomas DiNapoli has disputed the
report’s findings, claiming that the IDC did not
take into account that the pension fund’s assets
under management have fluctuated significantly over the past
several years, which also drives fees. Perhaps the biggest part
not taken under consideration was the move away from funds of
hedge funds to a broader direct hedge fund programme, which was
originally put in place to save on fees.
In fact, in other states where placement agent scandals hit
home (such as New Mexico and California) most pensions have
generally taken on more single-manager hedge funds at the
expense of FoHFs – in the name of saving fees. In
general, many public pensions have embraced the
direct-allocation approach and use of specialist consultants in
the name of fee reduction (
see March’s Institutional Letter).
In New Mexico, the $15 billion retirement fund has had
redemptions totalling more than $1 billion since 2008 and saw
liquidations of 13 funds, leaving only three FoHF managers in
the portfolio. In California, 2008 marked a time of significant
negotiating with hedge fund managers lowering fees in exchange
for longer lock-ups or other provisions.
In an independent report on the Kentucky Retirement System,
attorney Edward Siedle recently pointed out that following a
review of placement agents at CalPERS, the pension plan was
able to negotiate $215 million in fee reductions from
alternative asset managers. Kentucky also has found itself in
the middle of a placement agent scandal that is still being
investigated by the SEC (see
The risk of inflated manager fees is heightened if a
pension, such as Kentucky, does not solicit competitive bids
from investment managers, according to Siedle.
It is a seemingly logical conclusion, but in light of the
ban of placement agents going forward, is this
'politicisation’ of mandates a real or imagined
concern? It might be that hedge fund consultants or advisors
forming strong ties with public pension boards across the US
should stay out of local politics. Seeing what historically has
played out, ensuring transparent and fair business practices
will be the key to lowering a lingering
'corruption’ fee that trustees can’t
afford if they want to meet their obligations.