CalPERS touts declining PE fees, doesn’t factor in fund expenses

  • CalPERS used to budget PE management fees, expenses together
  • Expenses are no longer accounted for in the CalPERS budget
  • CalPERS paid $75 mln in PE expenses in 2015-2016, almost a fifth of its costs

In April, the board of California Public Employees’ Retirement System praised a proposed budget that slashed $131 million from the annual fees the system pays to its private equity managers, bringing projected fees to $260 million.

Unlike previous years, however, CalPERS’s proposed budget for PE-management fees in the 2017-2018 fiscal year does not factor in expenses private equity firms bill to their fund investors, including amounts for legal and auditing services. Though CalPERS still pays these expenses, they are not accounted for in its new budget proposal, CalPERS spokespeople told Buyouts.

For a portfolio of CalPERS’s size, roughly $25.7 billion, annual PE fund expenses can run in the tens of millions of dollars. In the year that ended last June, CalPERS paid around $75 million in partnership expenses. That was on top of the $206.5 million in management fees it paid to the general partners of direct private equity funds, along with roughly $69 million of fees for various funds-of-funds programs. All told, partnership expenses represented more than 20 percent of CalPERS’s PE costs, retirement system documents show.

It’s not clear how much fund expenses for the current fiscal year could total, so it’s also unclear how much of the $131 million in fee savings touted in the budget is due simply to separating fund expenses out of management fee reporting.

Other factors that influenced the reduction were the aging out of older, higher-cost funds, along with lower fees on newer investment vehicles. Spokesman Wayne Davis said partnership expenses will be presented to the board as part of the retirement system’s annual review of its PE program in November.

Board members contacted by Buyouts offered differing accounts as to whether they were aware that at least part of the projected fee reduction was due to the elimination of fund expenses from the budget.

Investment Committee chairman Henry Jones told Buyouts he was aware of the shift. In an email, Priya Mathur wrote, “we are aware of the private equity fees and partnership expenses we pay directly,” adding that she was confident of the 2017-2018 fiscal year budget projections.

Board member JJ Jelincic, who criticized CalPERS staff in the past for not accurately tracking private equity fees and carried interest, said staff had not disclosed that private equity expenses were no longer included in the budget.

“They gave no indication that the various fees we paid were not included there. It’s a little surprising,” he said an interview. “It’s actually less accurate than the information we’d had [before]. We’re going to produce a financial statement that we know is less accurate.”


In interviews, CalPERS spokespeople attributed the elimination of partnership expenses from the budget to a shift in how the nation’s largest public pension monitors its PE portfolio’s fees and expenses.

CalPERS launched its Private Equity Accounting and Reporting System, or PEARS, in early 2015. The new accounting system allows pension staff to segregate annual management fees from the other fund expenses that private equity GPs charge to LPs.

In the past, those expenses were often lumped together with management fees in private equity fund tax documents, CalPERS spokeswoman Megan White said. CalPERS finance staff used those tax documents to formulate the retirement system’s annual budget.

CalPERS staff was unable to extract fund-related expenses from private equity management fees, which is why in previous years they were presented as a lump sum in budget proposals and other retirement-system documents, including its annual financial reports.

In the budget proposal presented last month, staff credited PEARS for helping them more accurately capture and account for the costs of the private equity portfolio. The proposal did not disclose that partnership expenses were excluded from the amount budgeted for annual management fees, even though CalPERS is “on the hook for all obligations specified in the partnership agreement,” White wrote in an email.

In fact, even though the expenses CalPERS incurred from private equity partnerships were included in the management fee tally in 2015-2016 budget materials, those costs were excluded from what was later reported in its 2015-2016 consolidated annual financial report.

This year, “the decision was made not to include them so that our budget and CAFR would be in alignment going forward,” Davis said in an email.

CalPERS staff did disclose partnership expenses in the annual review of the retirement system’s private equity program presented to the board in November.

The budget

In the April meeting, CalPERS Chief of Financial Planning Rose McAuliffe told the board that steep cuts to private equity management fees were key to reducing the retirement system’s overall annual budget by $93.6 million. While certain administrative costs are projected to grow, the amount CalPERS expects to pay external investment managers across the entirety of its $318.9 billion investment portfolio fell by roughly $119 million.

The cuts to private equity management fees, as outlined in the budget proposal, represented the bulk of the retirement system’s declining costs.

“The cost decreases are mainly attributed to $119.2 million [in reduced costs] in the investment external management fees, mainly due to more accurate costing in the private equity accounting and reporting system, the PEARS system,” McAuliffe said at the meeting.

In its proposed budget, CalPERS staff said it expected the retirement system would pay the external managers of its private equity holdings around $260 million in management fees in the 2017-2018 fiscal year, a 33 percent reduction from the $391 million it budgeted for the current fiscal year ending June 30, 2017.

The budgeted $260 million also appeared to represent a significant decline from what CalPERS paid in the previous fiscal year, which ended last June. CalPERS said it paid its private equity managers a little more than $353 million in external management fees last year. That total included amounts for partnership-related expenses like auditing and legal fees.

Despite the elimination of private equity expenses from the budgeting process, board members applauded the cuts.

“It seems each year there’s been an improvement [in fees],” Jones said at the April 18 meeting. “Especially the $119 million [reduction] in fees, in the investment office. I think that we should really publicize that and let people know we’re being more efficient in our investment strategies.”

Those comments were echoed by other board members, including Mathur, who called the cuts “no small potatoes.”

Other cuts

Other factors influenced CalPERS’s projection that private equity management fees would fall in the coming year, Davis and White said. The retirement system will stop paying management fees on older funds that will expire in the coming years. Typical PE funds are marketed with 10-year lives, usually with one or two annual extensions.

CalPERS has negotiated lower management fees on newer funds in its private equity portfolio, which will also play a role in bringing down costs. As older funds phase out, CalPERS replaces them with newer funds with smaller annual fees.

On average, CalPERS will pay an annual management fee of 1.08 percent on the funds it committed to in the 2015-2016 fiscal year, according CalPERS’s documents. Four years ago, CalPERS’s average annual management fee was 1.22 percent.

The retirement system is also collecting a larger share of the profits generated by its PE fund holdings, retirement system records show. CalPERS managers who received a fund commitment in 2015-2016 will collect 14.55 percent of their funds’ profits as carried interest, considerably less than the 20 percent considered the industry’s standard

CalPERS CIO Ted Eliopoulos is weighing other ideas to bring down the fee burden of its private equity program as well, Davis said. The retirement system may purchase a private equity firm to source more direct deals, or staff might begin pursuing more direct investments in private companies on their own, The Wall Street Journal reported earlier this year.

“Ted is going to present some ideas on how we can keep cutting those fees, because they’re enormous,” Davis told Buyouts.

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