Sunday, 8 February 2015

Pension funds giving up on hedge funds is just the start

One of the more inexplicable aspects of pension fund behaviour in recent years has been their tolerance for high fees, particularly in relation to alternatives. To state the obvious, high fees - especially where the manager takes a slice of your return - inevitably make it harder to deliver the returns you need in order to fund retirement benefits. What is more, the amount that leaks out of our pension system in fees has increased in recent years as funds have stuck more into alternatives - mainly private equity and hedge funds.

If you read some of the commentary from industry insiders you get a sense that they can hardly believe that clients put up with the fee levels. For example, Simon Lack has written a whole book basically arguing that hedge funds returns aren't worth the cost and that the industry is much better at making the managers rich than the clients, and Guy Fraser-Sampson's book expresses surprise at the lack of pressure on fees in private equity, see comments here.

But perhaps things are starting to change. In the last few months there have been several high-profile moves by pension funds to cut their alternatives allocation. CalPERS has closed it hedge fund programme, blaming costs, complexity and lack of scale. PFZW (PGGM) is pulling out of hedge funds, citing complexity and costs as a reason. In the UK, Railpen is cutting its hedge fund allocation significantly because of what is says is a poor cost/return trade-off, West Midlands is pulling out and LPFA criticised the industry's '2 and 20' fee structure. CalPERS is now also planning to cut the number of its private equity managers. Again, cost reduction is a driver.

These are small moves to be sure. The fee structure for alternatives is a rip-off, but there is plenty of leakage via 'traditional' asset management too. So there is a much bigger problem to tackle. But it is encouraging that pension funds are starting to challenge at least some of the most obviously wasteful investment activity out there.

I've thought for a long time that fees/costs in the pension system are an obvious place for the Left to intervene (only we can do it - the Right relies far too heavily on finance as a source of political and financial support to be able to act effectively). Since then there has been great work done on pension costs by Labour in opposition, and also on fund management fees by Unison. But this is just the beginning.

This is surely an issue where trade union reps in the governance of pension funds can be key. There is a great opportunity to reduce the costs that cut our pensions and, in doing so, challenge "socially useless" finance. It is a challenge we should embrace.

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