CalPERS omits millions in PE expenses from annual report

  • Partnership expenses, fund-of-fund fees no longer included in annual report’s PE costs
  • Those amounts will be noted in future reports
  • Fund-of-fund fees, expenses amounted to more than $120 mln for CalPERS in FY 2015-2016

California Public Employees’ Retirement System left more than $120 million of private equity fees and expenses off of its annual financial report by claiming those costs were not related to investments.

The fees and expenses, which were excluded from its 2015-2016 annual report, include $75 million in legal and auditing expenses for investment funds in CalPERS’s $26 billion private equity program. The annual report, known as the CAFR, also excluded roughly $46 million in management fees paid to the underlying investment vehicles held through funds-of-funds.

CalPERS finance staff had reported those expenditures in previous years, along with the annual management fees it pays to each of its private equity managers, as a single lump sum. The accounting change wasn’t mentioned in the 2015-2016 CAFR, which contributed to the appearance that CalPERS had trimmed more than $200 million of investment-related fees and costs from its PE program between the 2014 calendar year — the period captured by the previous year’s report — and the 2015-2016 fiscal year.

Although the fee-and-expense information was not included in its most recent CAFR, Chief Operating Investment Officer Wylie Tollette said staff plans to include information about fund-of-fund and partnership expenses in future CAFRs. It will continue to be included in PE program updates, he said at CalPERS May board meeting.

At its November meeting Tollette had notified the CalPERS board that staff had changed how it calculates and discloses some private-equity-related expenses in annual financial reports. In addition to Tollette’s comments, CalPERS notified the board of its decision to move certain fees and expenses out of the CAFR in footnotes to a November budget document.

However, the accounting change wasn’t noted in its actual report, and CalPERS made similar omissions in subsequent budget documents and a news release about the cost of its investment program. The news release was later updated to reflect the $75 million in partnership expenses and $46 million fund-of-fund fees.

Public pensions typically provide supplemental material to notify analysts of any changes to their accounting methodology within their CAFRs, which affects assessments of their finances. The health of a state or local public pension often weighs heavily on the creditworthiness of bonds issued by state, county and municipal governments.

“There’s a reason you won’t find the footnote [in the CAFR]; there isn’t one,” Board Member JJ Jelincic said in an interview. Jelincic says he submitted a memo covering several concerns with the PE program, and how its costs are reported, to CalPERS Finance Committee Chairman Richard Costigan.

Jelincic and others raised questions about the disclosure of certain fees and expenses in the period between CalPERS’s April and May board meetings.

“Ratings agencies will look at CAFRs and use those as a function to rate the government’s debt,” said Andrew Biggs, former deputy commissioner of the Social Security Administration and associate director of the White House National Economic Council. Those agencies, and other investors, may look askance “if you have money related to a pension’s administrative costs and that’s taken off the books.”

“People are rightfully skeptical of a lot of what goes on at pensions, so you have to go the extra mile. If it looks like you’re trying to hide something, you’re going to lose that confidence,” Biggs added. “CalPERS is a leader in a lot of things. And to me, it makes sense to go the extra mile.”

‘Investment-related costs’ 

Government accounting standards require public pensions to list all “investment-related costs” as expenses within their financial reports, but those standards also give officials wide latitude in deciding whether an expense is investment-related.

Some, such as Missouri State Employees’ Retirement System, break out each private fund’s expenses and list them as an expense in their CAFRs. Others, such as Washington State Investment Board, treat them similarly to CalPERS. Others still, like California State Teachers’ Retirement System, don’t include any information about management fees or fund-level expenses within their annual financial reports.

CEM Benchmarking, an investment-cost consultant to CalPERS and dozens of other large U.S. public pensions, has generally advocated for public pensions to include as much information as possible about private equity’s myriad fees and expenses in their CAFRs.

“We believe it is a cost that should be reported,” said Jody MacIntosh, a vice president at CEM. Many public pensions lack the tools to identify and separate fees and expenses, but “our view is anything that would stay in the GP’s pockets would be an expense.”

CalPERS launched a new, automated accounting system in mid-2015 that enables the $323.5 billion pension to separate PE’s complicated fees and expenses into their component parts. (See: A quick primer on private equity’s fees and expenses at the bottom of this story.)

In previous years, CalPERS fee-and-expense data was calculated by pulling information from K-1 tax documents. The amounts represented estimates of what was paid each calendar year, rather than CalPERS’s fiscal year ending June 30.

After implementing its new system, CalPERS identified significant expenditures it deemed to be unrelated to each private equity fund’s investment activity. For the first time, the retirement system earlier this month formally approved a budget that excluded the costs.

“No costs were removed,” spokesperson Megan White wrote in an email. “The prior-year figures were calendar year-based estimates drawn from the K-1s that included a variety of expenses and fees that should never have been included if we had complete and accurate record-keeping, as we do now.”

CalPERS defended its decision to extract certain private equity fees and expenses by saying the amounts are analogous to what General Motors pays for steel and labor. The retirement system owns roughly 5.5 million shares of GM, but the automaker’s steel and labor costs belong to GM, not CalPERS.

“The legal, audit and consulting costs incurred to maintain a limited partnership whose business is the buying, restructure and selling of companies are the costs of that business, not ‘investment-related costs,’” White wrote.

Moving forward, “we do absolutely plan to continue disclosing those expenses in the CAFR and in the program review,” Tollette said at the May board meeting. The retirement system will also continue to report carried interest collected by its PE fund managers in its CAFR, which it did for the first time last year.

More information on fees

In certain ways, CalPERS discloses more about its PE program than most other pensions, many of which lack the staffing, resources or desire to present comprehensive overviews of their program’s true costs. While private equity fund expenses and fund-of-fund fees were excluded from its audited financial statements, they were disclosed in other budget and investment documents presented to the board throughout the past several months.

That’s considerably more information than what’s released by most public pensions, and CalPERS’ interpretation of what represents an investment-related cost is more expansive than that of many of its peers — including CalSTRS.

CalSTRS omitted PE management fees from its financial reports in each of the past several years, claiming management fees and expenses represent “indirect costs” to its investment portfolio, according to pension documents.

Those “indirect costs” are substantial. Another report, separate from its CAFR, clarified that the retirement system paid $195.6 million in management fees and $139 million in partnership expenses and other fees last year. Their exclusion, which is noted in CalSTRS’s CAFR, enables the pension to depict its $16.3 billion private equity portfolio as costing just $7.8 million.

“In most cases, [fund expenses are] not being reported as a cost now, in CAFRs, because LPs aren’t getting good information from their general partners,” MacIntosh told Buyouts.

That doesn’t appear to apply to CalPERS and CalSTRS, however. Both retirement systems invested heavily in new reporting systems — or internal projects — to identify and separate each of private equity’s individual fees and expenses. Both institutions endorsed the Institutional Limited Partners Association reporting template, which was intended as a way to standardize how general partners report each of PE’s individual costs.

The question of how each public pension will then report those costs, or whether they’ll even characterize them as an investment-related expense, remains unsettled, sources told Buyouts.

“I think they should identify those costs as itemized as they can,” a deputy CIO at one public pension, who wasn’t authorized to speak on the record, told Buyouts. “They ought to disclose that in the [consolidated annual financial] report and tell the reader why.”

Action Item: For more information about CalPERS, visit

Historic California capitol building in Sacramento with lawn and walkway. Photo courtesy Ron and Patty Thomas/iStock/Getty Images.

A quick primer on private equity’s fees and expenses

Private equity firms charge their fund investors, known as limited partners, a variety of fees and expenses that are often difficult to ascertain or segregate. The firms also charge a variety of fees and expenses to the companies they own through their funds. Determining who’s responsible for those costs, or how they should be reported, is complicated.

LPs pay the private equity firm in charge of each fund an annual management fee. The management fee is separate from partnership expenses, which are also billed to LPs through the fund to pay for things like auditing and legal services. Charging higher fees and expenses to LPs reduces their net returns from the private equity funds.

Partnership expenses and management fees are distinct from the fees PE firms charge their portfolio companies. Fund investors don’t directly bear the costs of those fees, but they can diminish the aggregate value of the funds’ portfolio companies, which can hurt the funds’ net returns.

In addition to collecting a variety of fees and expenses from their LPs and portfolio companies, PE firms usually collect a share of whatever profits its funds generate — and some LPs view that as an additional cost.

Ultimately, to get a full understanding of private equity’s fees and expenses, LPs must track the fees and expenses they pay to their fund managers, the cash the fund manager extracts from the fund’s portfolio companies, and whatever share of the return the GP decides to keep as its own.