Editor’s Letter: Pew gets on board with making private equity fully transparent

The push for complete transparency in private equity just gained a major ally: The Pew Charitable Trusts.

Pew, a nonprofit research organization, recently released a study that advocates for the public disclosure of private equity fees and expenses, including carried interest.

Transparency is vital for an industry that has become increasingly important to the fiscal health of public pension plans and the retirees they represent.

“Policymakers, stakeholders, and the public need full disclosure on investment performance and fees to ensure that risks, returns and costs are balanced in ways that follow best practices and meet funds’ policy needs,” according to the February report, called “Making state pension investments more transparent.”

Pew collected fee and performance data from the 73 largest public pension funds in the United States, which collectively have about $2.9 trillion in assets. These plans have almost $2.2 trillion invested in equities and alternatives, which include private equity. Exposure to alternatives, including private equity, real estate and hedge funds, across the 73 plans more than doubled from around 11 percent in 2006 to 25 percent in 2013, the study said.

The funds paid about $10 billion to manage alternatives in fees and expenses in 2014, according to the study.

“These fees can reduce investment returns on alternatives by as much as 10 to 20 percent,” the study said.

These numbers show the increasing importance of alternative investments at public systems, which many public pension officials believe is necessary for them to meet their investment return goals. Meeting these targets is important for these systems to be able to continue paying retirees.

But with this increasing importance comes the increasingly important role of transparency into how much alternatives actually cost. Many systems traditionally haven’t tracked how much they have paid out in carried interest. The California Public Employees’ Retirement System last year revealed it paid out $3.4 billion in carried interest over 25 years. The South Carolina Retirement System has reported on carry for several years, resulting in it reporting the some of the highest fees in the country.

Pew recommends public systems adopt a new reporting template published by the Institutional Limited Partners Association that tracks fees, expenses and carried interest collected by the GP. The study recommends systems report both gross and net returns to provide information on “both the cost and bottom line results of pension funds’ investment strategies.” For 10-year results, 27 of 73 plans (37 percent) studied reported only gross returns.

“A direct comparison of returns on a net and gross basis is a clear and easy method for examining the impact of fees on fund performance,” the study said.

Pensions also should provide 20-year returns to better reflect the long-term nature of the funds’ investments, which also would give a better perspective on the funds’ performance through cycles. As well, systems should report individual asset classes returns both gross and net of fees over 20 years, the study said.

“Long-term performance data must be available to assess the overall success of the investment strategy,” the study said.

Finally, pension funds should make their investment policies transparent, the study said. Most of those studies already make them public and this should be standardized across the country.

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