Pennsylvania examines fees, sets $750 mln pace for PE

The Pennsylvania State Employees’ Retirement System has joined a growing number of public pensions taking a closer look at private equity fees.

The $26.5 billion retirement system’s 2016-2017 strategic investment plan includes a review of the fees charged by its fund managers, it announced on December 9.

The review tops the list of initiatives SERS plans to undertake over the next two years. Pennsylvania will conduct the review to see “if fees are aligned with SERS’ best interests and are reasonable relative to market rates for comparable strategies in each investment asset class,” according to its strategic plan.

The retirement system did not set a timetable for when it would complete its review, said Pennsylvania spokeswoman Pamela Hile.

Other public pensions that have launched reviews of their portfolios in recent months include the State of Wisconsin Investment Board and Los Angeles County Employees Retirement Association (LACERA).

Fees charged by the private equity industry face particular scrutiny after several SEC enforcement actions targeted alleged abuses by fund managers in misallocating fund fees and expenses. The California Public Employees’ Retirement System and California State Teachers’ Retirement System revealed that they did not track the amount of carried interest taken by managers as profit share.

“Over the last couple of years we’ve reduced fees,” Hile said. “It’s not something new, but the recent focus has had us refocus on it as well.”

Pennsylvania cut annual investment costs by $73 million — from $260 million to $187 million — between 2009 and 2014, according to pension documents. The management fees charged by its alternative investment managers, including private equity general partners, fell by more than 40 percent during the same period.

SERS does not count carried interest toward overall investment costs, since the retirement system considers it be a profit-sharing agreement with its GPs — not a cost, Hile said.

While that view is shared by most public pensions, a growing number of retirement systems now publish the amount of carried interest collected by managers. In November, CalPERS published a report detailing the share of profits taken by most of its active GPs.

It is not clear whether Pennsylvania’s review will include carried interest, Hile said. “The scope has not been determined,” she said.

Lower allocation, faster pacing

In addition to launching a review of manager fees, Pennsylvania set plans to commit approximately $750 million annually in each of the next two years. The new pace represents a 50 percent increase from its current pace of around $500 million, according to the summary.

Its commitments will likely be larger — as much as $100 million or greater in size — as Pennsylvania seeks to form “long-term strategic partnerships, improve operational efficiency by reducing the number of funds, and improve SERS’ leverage to negotiate lower management fees,” the summary said.

SERS sized most of its private equity commitments at approximately $50 million in 2015, according to pension documents.

GPs often offer fee breaks to limited partners who write bigger checks. For example, LPs that committed $200 million or more to The Carlyle Group’s latest middle-market buyout fund received an 11 percent discount on their annual management fee, according to LACERA documents. Likewise, Blackstone Group regularly charges its LPs lower fees in exchange for larger commitments.

Larger commitments also provide LPs with greater leverage in negotiating other terms, such as seats on a fund’s LP advisory committee or access to co-investments.

Despite planning larger commitments to private equity, Pennsylvania has been gradually scaling down its allocation to the asset class over the last several years. Steep declines in public equity valuations during the financial crisis caused private equity’s share of the overall portfolio to rapidly increase. The asset class represented more than a quarter of the Pennsylvania’s investment portfolio in December 2010.

Pennsylvania set about reducing its exposure to private equity in 2012 when it slashed its target allocation to 16 percent, pledging to cap annual commitments at $500 million. The pension also engaged the secondary market, selling a $1.75 billion portfolio of fund stakes to Ardian earlier this year.

Those efforts helped bring the pension’s private equity allocation to around 19 percent as of June 30, 2015. According to SERS’ pacing analysis, committing $750 million per year should bring the pension in line with its long-term target allocation.