A report by the American Federation of Teachers (AFT) says that excessive fees charged by Wall Street fund managers are hurting public pensions funds.
Calling the fees an unfair transfer of wealth from working people to Wall Street, the report recommends that public pension funds renegotiate the fees that fund managers are charging and demand more fee transparency from the managers.
For many years, most public pension funds invested in traditional assets such as bonds and high quality stocks.
But during the last 15 years, pension funds have substantially increased their investments in alternative assets such as private equity funds, hedge funds, real estate, commodities, and derivatives.
The AFT report estimates that 25 percent of public pension investments are now in alternative assets.
Alternative assets have become an attractive investment because they offer higher rates of return.
The problem, according to the AFT report, is that the investment firms managing the alternative asset investments for pension funds charge high and hidden fees that substantially reduce the pension funds’ rate of return on investment.
The report, entitled The Big Squeeze, said Randi Weingarten, AFT’s president, “documents the harm to pension funds and state budgets” done by the oversized and hidden fees of alternative asset fund managers.
One of the oversized fees referred to by Weingarten is a 2 percent fee on managed assets called a performance fee. Fund managers get the fee whether the investment’s performance is good or bad. The other is a 20 percent share of gross profits that fund managers take off the top.
Weingarten said that AFT is working with pension funds to reduce the 2/20 fee structure. Doing so would save billions that could be used to make pension funds stronger.
The Big Squeeze examines 12 large public pension funds that have invested in alternative assets.
Alternative assets have become more popular because the companies that manage them have marketed them as high-return investments.
But the promised higher returns come at a price.
The companies that sell and manage alternative asset investments charge hefty fees for their services.
In addition to the typical 2/20 fee structure, fund managers also charge fees for administration, legal services, and transaction services.
We know that these additional fees mount up over time, but we don’t know by how much because fund managers won’t divulge the amount of the fees. That information, according to managers is proprietary information not for public disclosure.
These hidden fees, which can be substantial, deprive investors of information they need to know.
The Big Squeeze recommends that pension funds demand that asset managers fully disclose all their fees and that pension renegotiate the standard 2/20 fee structure.
The report recommends reducing the standard fee structure to 0.9 percent of funds under management and 9 percent of profits.
Had the 0.9/9 fee structure been in place, the 12 pension funds examined in The Big Squeeze would have saved $3.8 billion a year, or $19 billion over five years.
The savings and the return on investment that the savings would have generated would have gone a long way toward securing and fortifying the retirement security for millions of workers.
Some of the pension funds examined in The Big Squeeze are under funded. That is, their assets to liabilities ratio over a 31-year period is below 80 percent.
Right wing critics of defined benefit pensions have jumped on the under funding problem citing it as the main reason that pensions should be eliminated and replaced with less secure retirement savings accounts.
The Big Squeeze argues that reducing alternative asset fees and making them more transparent would return billions to pension funds and put them on a path toward full funding.
Weingarten said that there is evidence to show that cutting excessive fund management fees can help pension funds regain their financial footing.
“By calling out these pernicious practices and working closely with pension trustees and legislative allies, we’ve begun to see fees cut and fee structures for hedge fund and private equity managers exposed,” said Weingarten. “This is a win-win situation—revealing these practices means would-be fees are redirected back into retirement systems to address the so-called under funding of (pensions) and to ensure retirees can get the retirement security they’ve been promised.”