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Ashby Monk, Ph.D., executive director of the Global Projects Center at Stanford University and a senior research associate at the University of Oxford, has been blogging about sovereign and pension funds since 2008. 

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Fees Are Out of Control, Returns Are Not

Julie Creswell of the New York Times sums up pretty succinctly why so many institutional investors are rethinking the way they do business: “...while their fees have soared, their returns have not.” She points to the case of the Pennsylvania State Employees’ Retirement System, which has paid “...$1.35 billion in management fees in the last five years and reported a five-year annualized return of 3.6 percent.” Value for money? No. It seems to me, fees are out of control. This is a world where a man can lose ten billion dollars over the past decade, net, and still get to be a billionaire himself. I wish I were joking. But I’m not

As Institutional Investor pointed out in its story on AR’s Rich List, published last week, hedge fund managers became, and remained, billionaires “during the hardest period to make money on Wall Street in several generations — from 2001 through 2011 — when the Dow Industrials rose a total of just 13 percent, the Nasdaq Composite climbed a mere 7 percent and the Standard & Poor’s 500 lost nearly 5 percent.” And, “in three of the 11 years, the average hedge fund lost money.”

Forbes agrees, describing the 36 people who’ve become Billionaires from the hedge fund industry:

“The past year was an interesting one for this elite group. For starters, 2011 was officially the second worst year in the history of the industry, thanks to largely unforeseen levels of volatility in the commodity, equity and European debt markets that interrupted the international economic recovery. As a result, the average hedge fund was down approximately 5% last year. However, challenging markets didn’t stop the top three highest-earning hedge fund managers of 2011 from taking home billion-dollar paychecks.”

Fees. Are. Out. Of. Control.

You: ‘Nobody’s forcing pensions or sovereigns to buy these services. This is a free market.’

Me: ‘Bullocks. The politicians tell pensions to earn unrealistic returns and then give them no choice, due to insufficient resourcing, but to look to Wall Street for help. In other words, the only reason finance professionals get to charge the fees they charge is because the people that preside over institutional investors generally have no clue that if they paid their staff one tenth of what they’re paying Wall Street, they could replicate upwards of 80 percent of what they’re paying Wall Street to do.

You: ‘Stop being so naïve. Public pension funds could never hire the sort of talent that resides on Wall Street.’

Me: ‘Bullocks. Many funds already do; Ontario Teachers has been doing it for three decades with an IRR of 10 percent! And if public pensions started paying anywhere near market wages, I’d wager they’d get the talent they require too.’

Me Again: ‘To the Masters of the Universe, Here’s the truth: You make seven, eight, and, yes, nine figure salaries not because you’re so much smarter than everybody else on the planet. You make that much because the people who sponsor your clients (the institutional investors) don’t realize that a lot of what you do isn’t that hard.’

You: ‘Lies!’

Me: ‘Do you like apples? You do? Well, a friend of mine who runs a large public pension fund is saving, right now, over 100 million dollars per year by in-sourcing all fixed income strategies (while still meeting benchmarks). How? The in-house portfolios are managed at ~2 bps, while the external portfolio was being farmed out at 40bps. Boom. $100 million. How do ya like them apples

You: ‘Ummm.’

Me: ‘You know what’s actually funny about all of this? Well, not ‘ha ha!’ funny...more like ‘say what’ funny. The reason most politicians fall into this trap stems from the fact that most don’t connect the fees paid to external service providers with the costs paid to internal teams. Most funds have their budgets for “external fees” and “internal salary and headcount” separated. In fact, I’d say 90-95 percent of the budgets of these organizations don’t go through formal appropriation simply because they are in the form of external fees. As a consequence, the holders of the purse strings focus all their attention on 5% of the costs (salaries). They don’t understand – literally – that sending $200 million off to Wall Street could be avoided by spending $20 million on local talent...oftentimes with the same result.’

This is the dirty secret of funds management: The finance professionals get paid more than any other profession on the planet because the politicians and Boards refuse to properly resource their own funds (all the while asking them to make unrealistic returns). And this lack of resourcing (and overly aggressive return targets) gives the finance professionals asymmetric bargaining powers. And, as you might expect, they use it.

And this is why more funds will look to move assets in house. Not because they think they can do things better than Wall Street. But because they think they can do the same thing...at a tenth the price. And with the right commitment by policymakers, I think they might be right.

Leave a Comment    (6)

Trustees look much harder at fund staff salaries than what they pay their managers. Especially when fees are so often quoted in basis points, which let's be honest, hide the ball.

Apr 04 2012 at 11:17 AM EST

Marc LeBlanc
 

Thanks for the comments, all. In particular I like the reference to the prudent man rule and its lunacy. Winners in finance...innovate. Just look at OTPP. Just look at ATP. You get the picture. Prudent Man Rules force funds to do...what everybody else is doing. That needs to go! Thanks again for feedback. Ashby

Apr 03 2012 at 2:39 PM EST

Ashby Monk
 

Ontario Teachers is a good example, Healthcare of Ontario is another. Unlike US pensions where people go to work hoping to catch on to Wall Street, Bay Street professionals are joining pensions. You don't have to be smarter either but it helps. It is amazing the things you can do and squeeze when you run a large pool of capital that no smaller fund can do. everything from post less collateral to run tax incentivized swap trades to pick up basis points here and there.

Apr 03 2012 at 11:57 AM EST

Canadian
 

Very interesting! Very good article. I look forward to reading your articles on a daily basis.

Apr 02 2012 at 10:16 PM EST

Joyce Colvard
 

You shared with us ... "The finance professionals get paid more than any other profession on the planet because the politicians and Boards refuse to properly resource their own funds ..." That is still an "effect" and not the prime domino of causation.

When things don't make an ounce of sense its making someone a ton of money. With that as the "meta scope" of forensic diagnostics, the reason the system is what it is ... is because "the system" has set it up to work exactly the way it does.

Causation #1) Set up the case law of what is defined as the benchmarked "Standards of Prudence" and you have the trustees self-contained within the corral of fear … the fear of doing something "outside" of the norm of behavioral acceptance ... and the barbed wire of the fear of litigation and embarrassment has them frozen like the dear in the oncoming nighttime traffic. …. Or ….

Causation #2) The System of Master Trustees, Master Custodians, Investment Advisory Consultants … Investment Managers, etc. all are evangelists reading from the same bible … let us do it for you … let us protect and defend you… and … here are some added soft tangential benefits we will share with you, like soft dollars paying for trips … workshops in wonderful sunny places when you are freezing in the dead of winter … assist you to get your kids in the “right schools” … etc., etc., etc. Is the system prone to being a financial launder mat? Dahh! The smartest people in the world work the system folks … and every single self-sustaining “problem” has its beneficiaries. Eliminate the transparent systems of rewards and the problem’s source of causation atrophy’s.

Wisdom is simple. Ask wise questions and the results self-reveal. Deny the questions their day of reckoning and you get what ya got. Who’s truth do you really want?

Apr 02 2012 at 3:37 PM EST

Lawrence Carson
 

Ashby Monk is absolutely correct. More importantly, advisors reinforce bad behavior: the futility of chasing the allure of hot performance, which never can be sustained, resulting in an endless flipping of managers. Not a bad business model for the broker, but as Andy Monk points out not a good result for the consumer.

Given brokers do not comply with their fiduciary duties of being accountable for their recommendations and having ongoing fiduciary responsibilities, it is understandable why value is not added, but for advisors who more closely monitor and manage portfolios--this mystery of under performance is inexplicable.

The solution is more accountability, and the discovery of who are the better athletes, and who has been peddling down hill.

All advisory services firms have not been created equal. A new level of transparency with a metric of success akin to unfunded liabilities to define success in client specific ways tells us how well the consumer is served.

That sort of metric will resolve the highly profitable but ineffective practice of flipping of managers with a tangible quantifiable measure of progress made to achieving client objectives. Just having a client specific plan for achievement citing probability of sucess would self correct abusive industry practices.

Of course, this means highly personalized advice--the very definition of fiduciary counsel.

Will the industry respond in the consumer's best interest, or continue with the impression that it's counsel can be relied upon?

SCW

Apr 02 2012 at 1:30 PM EST

Stephen Winks