Last Friday, Cullen Browder reported on the level of fees now being paid by the NC Pension Fund. In the process, he interviewed yours truly. The video is here:
A big thank you goes to Ron Elmer who blogged about the fees on his investorcookbooks blog.
Ron compared the fund today vs. what it would have looked like had the asset allocation in 2000 been maintained using Vanguard index funds. His analysis is here.
The results are shocking. Fees as a percentage of the assets have increased by a factor 7 from 0.1% to 0.7% and the fund has gone from being overfunded to underfunded.
But it's not just fees - Ron also takes a look at the lost performance of the fund. Again, the results are shocking. The fund has underperformed by 1.8% per year over the past 10 years.
But it gets worse. If you look at the annual report for 2014 - 2015 - here: https://www.nctreasurer.com/inside-the-department/Reports/NCDST_Annual_Report_FY2014-2015.pdf you can start to add up all the fees that are being paid (for fiscal 2015).
Page 32: Total Fees: $538 Million.
Page 33: Fund of Funds Management Fees: $38 Million
Page 33: Fund of Funds Incentive Fees: $36 Million.
and in the Government Ops Report for June 2015, there are additional costs of $53 Million (presumably mostly attorney and consultant fees). (Again thanks go to Ron for spotting this).
Add all these together and you've got a total cost of $665 Million which on an $85 Billion fund is about 0.78%. So amazingly the total fees are approaching 0.8%! And given that this data is from last year, I'd fully expect the total to be higher now.
So what's going on?
Well - it's really hard to say, but a look at page 31 of the annual report can shed a little light.
Let's look at Global Equity - the second row. Global equity is benchmarked against the MSCI All World Index (AWI) Long Only - pretty reasonable, but also in the benchmark is a beta adjusted version to reflect hedged portfolios. My guess is that some of the Global Equities allocation is in long-short hedge funds - a very expensive strategy.
Or take a look at Opportunistic Fixed Income. Here 50% of the benchmark is in the HFRX Distressed Securities Index (the HFRX site doesn't seem to have the exact index that is described). The remaining parts of the benchmark cover stuff like leveraged loans and high yields. Bottom line, these are, in part, hedge funds buying junk and distressed debt.
So the takeaway is that the Pension Fund asset allocations are highly complex and as we've seen, very expensive. And yet, as we've seen from Ron's post above, this strategy is not paying off.
But what about risk? A frequent defense of the heavy use of hedge funds and private equity is that these assets provide risk reduction benefits to the fund. But the evidence doesn't support these claims. For example, in a recent Journal of Finance article Francesco Franzoni, Eric Nowak and Ludovic Phalippou find that private equity doesn't earn a positive alpha when you include liquidity risk. In a 2013 Review of Financial Studies paper, Adam Aiken, Chris Clifford and Jesse Ellis find that hedge fund index returns have a significant bias because only "winning" funds tend to report returns to the index creator.
The real question though, is even if these alternative investments are generating positive alpha (which I strongly doubt), are they generating enough to offset the 1.8% annual performance drag over the past 10 years?
I am pretty sure that they aren't even coming close.