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.

Rights Issue Fees Inquiry

Will blog about this later. Quick question - who is actually in/on the IIC?

2 and 20 = inequality

Another quick moan about fees... I'll kick off with a(nother) quote from John Kay's new book on the impact of the 2 and 20 fee structure (typically charged by hedge fund and private equity managers):

Suppose that [Warren] Buffett had deducted from the returns on his own investment - his own, not that of his fellow shareholders - a notional investment management fee, based on the standard 2% annual charge 20% of gains formula... There would then be two pots: one crteated by reinvestment of the fees Buffett was charging himself; and one created by the growth in value of Buffett's original investment. Call the first pot the wealth of Buffett Investment Management, the second pot the wealth of the Buffett Foundation.

How much of Buffett's $62bn would be the property of Buffett Investment Management and how much the property of the Buffett Foundation? The - completely astonishing - answer is that Buffett Investment Management would have $57bn and the Buffett Foundation $5bn. The cumulative effect of 'two and twenty' over forty two years is so large that the earnings of the investment manager completely overshadow the earnings of the invetsor. That sum tells you why it was the giants of the financial services industry, not the customers, who owned the yachts.

Similarly Nils Pratley makes the point today that the City has already made out like bandits:

private equity partners have enjoyed [a] privileged tax treatment. Carried interest – in effect, a bonus for good investment performance – is treated as a capital gain rather than income. This rate is 18%, and for many years was 10%. Given that advantage, a 50% rate of income tax ought not to be much to grumble about. The point is very simple: financiers enjoyed the fruits of the boom and being asked to pay more after the bust is reasonable.

He goes on to say that trying to tax the loot back off them might miss the point though.

I keep coming back to the view that one of the most 'progressive' things that lefties interested in how the financial system operates/could be reformed could do is co-ordinate a major push on fees. Not only do they eat a sizeable chunk of our savings and investments (far more, too, than the crumbs spent on corporate governance research and engagement), but this is how the City makes money to float free of the rest of society. Ultimately it's coming out of your pocket, and it's helping create disparity in wealth. Why wouldn't you be interested?