US pension hits out against high fees

The Orange County Employees’ Retirement System, which had net assets of $9.8 billion at the end of 2012, is becoming much tougher on investment fees, instituting policies to reduce the costs of the investment program and align its interests with that of its managers.

In an unusually public pronouncement for the usually quiet system, Orange County this week released its new fee policy that lays out the mechanics and rationale behind the move. The policy will affect the system’s alternatives program, which Orange County has been building up over the past few years, and will likely impact hedge funds primarily, but also private equity, real estate and private debt as well.

The system uses three funds of funds advisors for private equity exposure: Abbott Capital, Adams Street Partners and Mesirow Financial for real estate. The system’s target range for private equity is 5 percent, while its actual allocation stood at 3.3 percent as of March, according to pension documents. OCERS has a 10 percent target to real estate (with a 9.8 percent actual allocation as of March).

“What caught our trustees’ eyes was the large increase in indirect investment expenses, when they looked at the 2013 investment budget,” said OCERS chief investment officer Girard Miller. “Because those costs are indirectly charged against fund expenses, and not billed directly, they were not highly visible before.”

“The system’s indirect investment management fees jumped in the 2013 budget from $22 million to $45 million, according to documents from OCERS. “[That] was a compelling reason to revisit our fee policy and become more proactive in this space,” Miller said.

The system wants to reduce the cost of its investment operations to “the lowest sustainable level available in competitive markets for top investment managers”, according to the policy document. Its selection process will now include discussions about fees with managers up for consideration, and internally evaluate firms with fees in mind, before recommending a prospective manager for commitments, according to documents.

The system also will be looking to “obtain fee indications – including their willingness to negotiate meaningfully – from prospective managers before presentations to the committee”, according to the documents.

“Absent an evidently superior investment strategy and capability, or a discernible reason to expect materially

Girard Miller

superior investment performance from a competitor looking forward, OCERS will give selection preference to firms that offer the most advantageous fee structures,” the system said in the policy document.

Other fee preferences include “multi-year fractional holdbacks or clawbacks”; base fees should be at levels to pay OCERS’ share of fixed costs and basic operating expenses, but not bonuses.

The system also will speak with existing managers in the portfolio about lowering fee levels, though not private equity managers, Miller said. Instead, the system will wait until existing private equity managers come back for re-ups to talk about lowering fees, he said.

“The deal is the deal, you don’t have the opportunity to renegotiate a fund that is already closed, that would be highly irregular,” Miller told Private Equity International in an interview Monday.