Taxpayers foot $850M bill for Wall St.'s pension fees
New York City taxpayers are helping to pay $850 million in Wall Street investment fees -- even as these financial gurus have produced only meager results for strapped city and state pension funds.
City Comptroller John Liu this week released a comprehensive analysis of NYC pension costs over the past decade, revealing why they have risen from $1.2 billion to $7.7 billion.
Liu said one of the major factors in the shortfall was higher than expected investment and administrative fees, which were $71 million in 2005, and have risen more than four-fold to $313 million.
Nearly all of the increase was due to the pension funds shifting asset allocation in favor of private equity and real estate -- chasing bigger returns -- but which also have higher investment fees, he wrote.
The state pension fund, which made a similar shift, saw its expenses rise in five years from $277 million to $433 million. Add in the teacher pension fund, and total fees in 2010 reached $848 million.
These higher fees aren't paying off. The City pensions (which cover teachers, cops, firefighters and other municipal employees) saw annual returns for the last five years of a meager 2.8 percent, but even that is better than its 10-year 2.5 percent record.
But, with the target return at 8 percent -- which is more a political than fiscal decision -- taxpayers are forced to make up the shortfall.
But pension beneficiaries are protected by the state constitution's impairment clause, which does not allow for diminished benefits, even for budgetary needs.
The pensions have a guaranteed return of either 7.5 or 8 percent a year, and any shortfall must be made up by taxpayers.
Taxpayers' share of city pension costs have exploded 900 percent in the last decade from $703 million in 2000 to $6.5 billion in the 2010 fiscal year, according to the City Comptroller's office.
The City now spends 11 percent of its expenses on the pensions, up from six percent five years ago.
Harry Wilson, the Republican who lost the 2010 election for state comptroller, believes pensions are swinging for the fences by making risky investments to hit unrealistic targets. "My thought process is you have a promise to certain people, and therefore you want to have a low-risk asset mix to meet those obligations."
The State pension, by moving to riskier investments, has had similar results: a 4.28 percent five-year average that is better than the 3.7 percent 10-year, but well short of its 7.5 percent target.
At the same time, the New York State Teachers fund, which has also ramped up its private equity investments, has actually seen its returns fall to a 2.28 percent five-year return from a 2.7 percent 10-year mark.
Had any of the funds simply invested in an S&P index fund, their return over 10 years would have been 18.1 percent.
Wilson said the higher fees "highlight that public pensions are paying more for active management and getting below-market performance."
The State has 13.9 percent of its investments in private equity and real estate, State Teachers more than 8 and the City Pensions 7.7 percent.
Private equity mostly means buyout funds run by firms like KKR that make money by buying companies on leverage and then reselling them within five years.
HEC Business School Professor Oliver Gottschalg, in a comprehensive August 2010 report, found that private-equity funds in existence for at least seven years perform broadly in line, after fees, with public market investments.
At the same time, he found funds with returns that are among the top 25 percent for any given year have a substantially higher performance compared to public equities. That is the appeal.
The New York State Teachers fund in its annual report said its goal was for its private-equity investments to outperform public equities by five percent.
Wilson, previously a principal at private-equity giant the Blackstone Group, said when pensions invest roughly $10 billion in PE funds, they do not have the luxury of picking the best performers, and not likely to get good results.
City Pension Chief Investment Officer Larry Schloss believes that since he was the former head of PE firm DLJ Merchant Banking Partners he can find the best funds, and better the average.
Schloss, though, is fighting back against private-equity fees. "We're telling any manager that comes to us that you need to cut fees."
Schloss said he is pushing firms to charge management fees only on invested money, and not on what they raise, which takes years to invest.
Lowering management fees from 1.5 percent to 1.25 percent is another goal. Still, he has not had a firm agree to these terms.
"The private-equity industry is changing, slowly," Schloss said.
City Comptroller John Liu this week released a comprehensive analysis of NYC pension costs over the past decade, revealing why they have risen from $1.2 billion to $7.7 billion.
Liu said one of the major factors in the shortfall was higher than expected investment and administrative fees, which were $71 million in 2005, and have risen more than four-fold to $313 million.
Nearly all of the increase was due to the pension funds shifting asset allocation in favor of private equity and real estate -- chasing bigger returns -- but which also have higher investment fees, he wrote.
The state pension fund, which made a similar shift, saw its expenses rise in five years from $277 million to $433 million. Add in the teacher pension fund, and total fees in 2010 reached $848 million.
These higher fees aren't paying off. The City pensions (which cover teachers, cops, firefighters and other municipal employees) saw annual returns for the last five years of a meager 2.8 percent, but even that is better than its 10-year 2.5 percent record.
But, with the target return at 8 percent -- which is more a political than fiscal decision -- taxpayers are forced to make up the shortfall.
But pension beneficiaries are protected by the state constitution's impairment clause, which does not allow for diminished benefits, even for budgetary needs.
The pensions have a guaranteed return of either 7.5 or 8 percent a year, and any shortfall must be made up by taxpayers.
Taxpayers' share of city pension costs have exploded 900 percent in the last decade from $703 million in 2000 to $6.5 billion in the 2010 fiscal year, according to the City Comptroller's office.
The City now spends 11 percent of its expenses on the pensions, up from six percent five years ago.
Harry Wilson, the Republican who lost the 2010 election for state comptroller, believes pensions are swinging for the fences by making risky investments to hit unrealistic targets. "My thought process is you have a promise to certain people, and therefore you want to have a low-risk asset mix to meet those obligations."
The State pension, by moving to riskier investments, has had similar results: a 4.28 percent five-year average that is better than the 3.7 percent 10-year, but well short of its 7.5 percent target.
At the same time, the New York State Teachers fund, which has also ramped up its private equity investments, has actually seen its returns fall to a 2.28 percent five-year return from a 2.7 percent 10-year mark.
Had any of the funds simply invested in an S&P index fund, their return over 10 years would have been 18.1 percent.
Wilson said the higher fees "highlight that public pensions are paying more for active management and getting below-market performance."
The State has 13.9 percent of its investments in private equity and real estate, State Teachers more than 8 and the City Pensions 7.7 percent.
Private equity mostly means buyout funds run by firms like KKR that make money by buying companies on leverage and then reselling them within five years.
HEC Business School Professor Oliver Gottschalg, in a comprehensive August 2010 report, found that private-equity funds in existence for at least seven years perform broadly in line, after fees, with public market investments.
At the same time, he found funds with returns that are among the top 25 percent for any given year have a substantially higher performance compared to public equities. That is the appeal.
The New York State Teachers fund in its annual report said its goal was for its private-equity investments to outperform public equities by five percent.
Wilson, previously a principal at private-equity giant the Blackstone Group, said when pensions invest roughly $10 billion in PE funds, they do not have the luxury of picking the best performers, and not likely to get good results.
City Pension Chief Investment Officer Larry Schloss believes that since he was the former head of PE firm DLJ Merchant Banking Partners he can find the best funds, and better the average.
Schloss, though, is fighting back against private-equity fees. "We're telling any manager that comes to us that you need to cut fees."
Schloss said he is pushing firms to charge management fees only on invested money, and not on what they raise, which takes years to invest.
Lowering management fees from 1.5 percent to 1.25 percent is another goal. Still, he has not had a firm agree to these terms.
"The private-equity industry is changing, slowly," Schloss said.
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