The California Public Employees’ Retirement System (Calpers) is back in the news again (I’ve written about them previously here and here).
This time, they’ve decided to disclose how much they’ve paid in performance fees to private equity fund managers and the number is a whopper at $3.4 billion.
Private equity, hedge funds and some other kinds of private funds are paid on what is known as a ‘2 and 20’ schedule which means that customers pay a two percent management fee and 20 percent of the profits.
Previously, Calpers reported the ‘2’ part of the equation, but didn’t report the ’20,’ which is often the most lucrative part.
For the fiscal year that ended in June, Calpers reported that the two percent management fees were $414 million. Not a small sum, except when compared to the performance fees that they paid, which were $700 million, bringing the total costs to more than $1.1 billion last year alone.
The $3.4 billion in fees that I referred to above is the cumulative performance fees paid since 1990, which includes last year’s $700 million.
As you might expect, fees that large really chopped down the performance of the Calpers funds. Over the last 20 years, Calpers private equity exposure earned an annualized return of 19.3 percent, which is pretty remarkable.
When you factor in the management and performance fees, the annualized return drops to 12.3 percent per year, which means that the fees acted as a seven percentage point drag on the results.
These are all staggering numbers, but the question is whether or not Calpers got any value for the fees that they paid.
It’s actually a little hard to say because they only posted the gross and net performance for private equity and real estate.
They said that their public equities earned 8.2 percent, but we can’t see whether that’s gross or net. Either way, it’s still four percentage points per year worse than their net of fees private equity performance, which is a big spread.
If you knew how things would work out in advance, of course you’d be willing to shell out any amount in fees so long as your net is four percentage points per year better than the alternative. If wouldn’t have mattered if the gross returns were 30 or 50 percent, so long as the fees didn’t wipe out all of the excess returns.
But you don’t know in advance. Their real estate allocation earned 9.3 percent gross of fees and 7.2 percent net of fees. Let’s assume that the 8.2 percent public equity returns are net of fees, although we don’t really know that.
If that’s the case, then real estate would have been a better opportunity but for those pesky fees, which caused the net return to fall below the equity return.
Yes, there was a diversification benefit that lowered overall portfolio volatility, but was there a cheaper way to access the real estate exposure? Indeed, the Dow Jones REIT index earned 11.09 percent per year for the same 20 year period in question.
Unlike you and me, though, Calpers is so big that they may not be able to get their full allocation invested in a relatively narrow asset class like REITs. They may have to invest directly in real estate, and maybe their returns look more like the private markets, I don’t know.
While we can say that private equity was worth the fees for the last 20 years, it’s reasonable to ask whether it will be for the next 20 years, and I don’t know the answer.
It seems to me that the lack of efficiency should result in higher returns for the top managers, but whether the gross return will be high enough to absorb the fees and still produce a higher return than the public markets is a tough question.