Five Questions with Stanford’s Ashby Monk on fee transparency

Stanford University Professor Ashby Monk advises pensions on innovative approaches to PE. He spoke with Buyouts about the dangers of pension fund complacency toward high PE fees.

1. You recently took to Twitter to disagree with a pension fund CIO who was happy to spend millions in PE fees to get billions in returns. Why?

In saying “millions to get billions,” you are in effect justifying a high fee to an external partner solely on the basis of the performance they delivered. But defining performance in absolute terms like this tells you very little. It doesn’t tell you how much risk they took, it doesn’t tell you the strategy or whether that strategy is commoditized. It doesn’t tell you if you could and should build that strategy internally or find partners that can offer better terms.

Over the last 30 years, you could have spent thousands to get billions by passively allocating to public markets on a direct basis. Does that mean anything to you? In my humble opinion, we should be worried if people aren’t defining why the millions were warranted.

The fee issue is the biggest driver of innovation among pensions today, and hand-waving away the fees with a generic platitude serves nobody, as it removes any incentive to be creative and innovative.

2. Should pension funds do more to highlight the fees they pay and more clearly label carried interest as a fee, rather than reporting it as profit-sharing?

By not presenting the truth about the fees and costs that are being captured by the managers, we miss an opportunity to have a broader conversation about how much wealth is being pulled out of pensioners’ pocket and deposited in the pockets of some of the most elite white dudes on Wall Street.

We limit the ability of stakeholders to engage in the pension plan by not presenting the total cost picture. Because those stakeholders may stand up and say, “look, there has to be a better way to go do this.”

Without making the fees and costs transparent — and I have to say calling carry a profit share is the opposite of transparent — how do we have this conversation about alternatives? We neuter the power to innovate by not reporting the true impact of the asset management fees.

3. You’ve spoken at CalPERS board meetings about their plan for two new CalPERS-controlled funds for specific PE strategies. What do you think about their approach?

Look, they had to do something different. They finally got serious about tracking their fees and realized just how much they were paying. And in that moment, people rightfully asked … “Is there another way?” That’s precisely the reason why fee and cost transparency is so important.

Now, CalPERS, unlike the Canadian pension plans, is not a crown corporation with arm’s length governance and the ability to compensate staff out of the asset base. That’s kind of the secret sauce of the Canadian model; they can set compensation very competitively. CalPERS doesn’t have that. So for CalPERS, the path to doing something internally would be a long and painful road and they would potentially never get there.

And so rather than full disintermediation, cutting out the GPs, they decided to go the path of reintermediation, creating a new path into the markets. And in that respect, I think they are doing the one thing that makes sense for them. They are seeding a new platform that is arms-length, that allows you to get the governance right, compensate right and control enough of the process to ensure alignment of interest.

4. Do you think governance or culture is a bigger factor in preventing more innovative thinking around PE fees in the U.S.?

I think it’s both. If you have the right governance in place, and you are creating incentives for people to think creatively and try new things, then they’ll do that. And a culture will evolve that is innovative and creative and that embraces failures as lessons for the future.

Let’s remember that there is no innovation without failure. We may not love that to be the case, but if you want to do something innovative, you’re going to fail at some point. And pension funds don’t know how to deal with failure. They’re not designed for that.

5. Are emerging manager programs a good way for pensions to mitigate some of the risks related to fees and alignment of interests?

I really like these programs. But still, this is innovation at the margins because you’re saying, we’ll carve out this tiny portion of our portfolio to help bring new managers into the market.

And that’s problematic because if [the rest of your portfolio is only backing more established funds,] where do the new funds come from? Your governance policies are literally reinforcing the hegemony of the existing players and allowing them to extract higher and higher fees over time because there’s less and less competition.

True innovation is asking, “can we change the way we invest, rather than change the makeup of the managers we invest in?”

This interview has been condensed for clarity.