As much of Pension America struggles to meet the promised benefits, significant work has been done to address the benefits through various tiers and changes to benefit formulas. There has also been a concerted effort to address the investment side with a significant shift from traditional asset classes, such as bonds and equities, to much greater emphasis on private markets, but at what cost, and is this move actually going to help plan sponsors and their consultants achieve the desired results?
Actuaries are fond to remind us of the pension equation:
C + I = B + E
Where C is contributions, I is the investment return, B is benefits paid and E is expenses, a big part of which are investment fees paid to managers.
Andrew Vo, CFA, Founder and CEO, Aidos, has penned an excellent article titled, “Venture Capitalists Are Getting Rich Off The Management Fees”, in which he discusses the concept of asset gatherers versus performance generators. He specifically focuses on VCs for his series of articles, but the same case can be made for hedge fund managers, too. The mega funds generate so much in management fees (2% in many cases), that a $1 billion AUM fund would generate $20 million per year and $200 million during the life of the fund (assuming the fund has a 10-year life) before the investors earn $1.
As mentioned above, Pension America is struggling in many cases to meet the promised benefits, and the move to private markets may not be the right course of action if at the end of the day these funds with these extraordinary fees don’t produce net results that exceed traditional asset classes, such as equities (private equity) or bonds (hedge funds). At the same time that plan sponsors are asking their employees (average Americans) to fork over a greater percentage of their salaries to help fund their retirement benefit, these same plan sponsors are rewarding the general partners of these funds with greater compensation packages. According to Mr. Vo, “many of these average Americans are government employees who rely on, and indirectly self-fund, their public pension plan, the same public pension that often misallocates capital to Venture Capitalists who earn 85X the salary of the government employees who partly funded them.”
If asset consultants and their clients continue to believe that investing in private markets – both equity and fixed – makes sense for the long-term viability of Pension America then let’s align all of the interested parties. Let’s adopt a new framework in which management fees of this magnitude disappear for good and a greater percentage of the outperformance is provided to the GPs of these funds, such as 30%. What do you think?