Sticker Shock: Lofty Fees, Low Returns
Illinois’ largest public employee pension fund paid more than $1 billion in fees to hundreds of financial managers over the past decade but reaped only a paltry annual return on its investments over that same period, according to a Better Government Association investigation.
The Teachers Retirement System (TRS) of Illinois--which represents thousands of school employees, is financially strapped and concerned about its long-term viability—paid more than $1.3 billion for money managers and brokerage firms to handle its $30 billion-plus in financial assets during a 10-year period ending in fiscal 2010.
Despite paying big money for high-powered investment expertise, TRS’ 10-year average rate of return during this span was a mere 3.7 percent excluding the cost of fees, far below its 8.5 percent annual target return.
Including fees, the pension's return during that period was 3.3 percent, according to TRS, which is just below the median return of 3.4 percent for public pensions during that period.
Almost 200 firms received more than $1 million in fees, while the top 10 firms averaged $38 million each during the 10-year period between 2001-2010, the BGA found.
Included in the top 10 is Washington, D.C.-based private equity firm Carlyle Group, locally-based Capri Capital Partners, and the now-defunct Commonwealth Realty Advisors co-founded by William Cellini, a Springfield-based powerbroker, who was convicted of extortion and bribery in federal court last November.
"It’s a shocking amount of money for very little value," says Frank Partnoy, professor of law and finance at the University of San Diego School of Law, and an expert on financial markets and regulation. "Two things are surprising: One is just the sheer dollar amounts, which are massive. The other is the number of vendors."
TRS disagrees with such criticism. In a written statement to the BGA, TRS said its payouts to money managers is in line with other public pensions of similar size and that its return was hurt by "steep losses sustained primarily during the 2008 and 2009 global financial crisis that pulled down the system’s 10-year average rate of return." TRS added that its investments rebounded with 2011’s 24 percent return.
While the pension fund’s returns have been uneven, the amount of money going to outside financial managers escalated over the decade. The BGA analyzed TRS fee information and found:
- From 2001 to 2010, TRS fees more than doubled from $83 million to almost $204 million. During that period, assets grew by a little more than one-third from $23.3 billion in 2001 to $31.3 billion in 2010.
- TRS paid more than $382 million, or about 28 percent of all its fees, to its top 10 money managers and advisers between 2001-2010, according to figures provided by TRS.
- Private equity firm Carlyle was by far the largest vendor for TRS during that 10-year period, according to figures TRS provided the BGA. TRS invested in 11 of that firm's funds, paying Carlyle more than $71 million. In 2010, TRS recorded declines for five of the Carlyle funds in which the pension invested.
- Real estate investment firms were well represented in the list of top 10 TRS financial vendors over the last decade, despite a downturn in that industry during the later years. In addition to Carlyle, four other firms, Capri Capital Partners, Commonwealth Realty Advisors, Koll Bren Schreiber Realty Advisors and LPC Realty Advisors collected tens of millions of dollars from the pension fund. Those four firms collected almost $136 million in fees from TRS between 2001-2010.
- Millions were paid to clout-backed Commonwealth Realty Advisors Inc. Cellini's now-defunct investment group received $30.8 million in TRS fees between 2001-2010—sixth highest on the top 10 list of financial vendors for the pension. Last November, Cellini was convicted on two federal charges stemming from an effort to extort money from a co-founder of Capri Capital, another investment firm doing business with TRS. (See related story)
The BGA hired Chicago-area pension consultant William Zettler to analyze brokerage and investment manager fee data received from TRS in response to an Illinois Freedom of Information Act (FOIA) request. The BGA also reviewed data on fees paid to the top 10 advisers during 2001 and 2010 provided by TRS in response to a FOIA request.
The Illinois General Assembly in 1939 created TRS, which includes full-time, part-time and substitute Illinois school personnel outside of Chicago.
As of last June, there were 170,275 active members, 104,222 inactive members who are entitled to but not getting benefits and 97,754 annuitants and beneficiaries receiving benefits. The average age of an annuitant was 69; the average annual retirement annuity was $44,844, according to TRS.
Between 2001 and 2010, hundreds of millions of dollars in TRS money went toward hiring various financial firms, according to the pension’s annual financial documents reviewed by the BGA.
The biggest recipient is Carlyle, one of the world's largest private equity firms and a vendor to many public and private pensions. Carlyle also has a controversial past.
In 2009, Carlyle agreed to pay a $20 million fine to resolve its role in an investigation of alleged public pension-related corruption in New York state conducted by Andrew Cuomo, who was then Attorney General and is now New York’s governor.
The politically connected Carlyle, which has a history of hiring high-profile politicians and influential operatives, also agreed to stop paying fees to middlemen, or placement agents, who would assist investment houses in getting state pension business. Such paid agents have been illegal in Illinois since 2009.
A Carlyle spokesman declined to comment on the firm's relationship with TRS.
As of December 31, 2011, TRS invested almost $421 million in Carlyle private equity investments and almost $90 million in the firm's real estate funds, according to TRS. As of December 31, Carlyle investments were valued at about $1.4 billion, according to TRS.
As of June 30, 2011, TRS' investment in Carlyle funds yielded a 14.5 percent annual return on investments after fees are deducted since 2004, TRS says.
The pension's fees paid to Carlyle cover a variety of investments, including distressed real estate in Europe, energy company buyouts around the world and leveraged corporate takeovers in the U.S.
TRS’ line-up of Carlyle holdings has some laggards: By the end of the 2011 fiscal year, two Carlyle funds continued to report declines, and one of those funds, Carlyle Ventures Capital II, represents a sizable TRS investment.
The pension fund paid more than $27 million in fees to Carlyle Ventures Capital II, which invests heavily in U.S.-based technology start-up firms, from fiscal years 2004 to 2010.
Yet during that period, that fund never produced more than single-digit investment returns and recorded two straight years of declines in 2009 and 2010, according to TRS figures. The fund continued to slide in 2011, reporting a 9.5 percent drop.
Asked if each Carlyle investment provided the type of high returns TRS hopes to get from private equity investments, the pension said in a statement: "To presume that every investment selected by any individual, money management firm or pension system will always develop positive returns is a false standard unknown in the investment world."
"While not every fund investment made to Carlyle has performed up to expectations, the total relationship has been highly successful," the TRS statement said.
(TRS spokesman Dave Urbanek said the pension fund would only respond to the BGA in writing and he declined to make investment leaders available for an interview. Of the top nine firms still doing business only LPC Realty would comment on this story.)
TRS also paid millions to manage its widespread real estate interests, which represented more than $4 billion, or almost 11 percent of assets in fiscal 2011, up from 10.4 percent in 2010.
In addition to the Carlyle funds, TRS' real estate portfolio includes sizable investments in local firms and properties over a 10-year period ending in 2010.
Capri Capital, Commonwealth Realty Advisors, Koll Bren Schreiber Realty Advisors and LPC Realty Advisors were paid $136 million in fees from TRS from 2001 to 2010.
Chicago-based Capri Capital is the third-largest recipient of TRS fees for that period, earning $46.4 million. LPC Realty Advisors I, the Chicago-based fund of Dallas-based Lincoln Property Co. is the ninth-largest TRS fee recipient, collecting $28 million. Koll Bren Schreiber was paid $30.6 million.
LPC Realty buys, manages and develops office and other commercial properties in Chicago and the suburbs. Following the market meltdown of 2008, real estate investments were hit particularly hard. But an LPC executive says her firm's fees are performance based.
"It's not like we're raking in money based on arbitrary amounts," says Jennifer Ratcliffe, president of LPC Realty Advisors I Ltd. "We really have to hit the ball out of the park."
An investment in LPC Realty declined more than 60 percent in fiscal 2009 and a Koll Bren Schreiber fund recorded a 65 percernt decline in 2010.
TRS' real estate investments rose almost 18 percent in fiscal 2011, compared with a 5.6 percent decline in 2010 and a 30 percent drop in 2009.
In the past few years, TRS has come under scrutiny from academics, the business press and state lawmakers, some of whom raised concerns about the pension’s financial health and the amount of risk being taken with its investments.
Like many other public pensions, TRS is woefully underfunded by the state. It has more than $81 billion in long-term liabilities and had enough to meet less than half of those obligations as of last June.
TRS would be $43.5 billion in the red if all its obligations had to be paid at once.
In the past, TRS asserted that would not happen because payouts to future and present annuitants will never come due at one time and are instead paid over decades. Recently, however, TRS has added that its underfunding, coupled with the state’s growing deficit, "throws the system’s long-term financial viability into serious doubt" and could mean insolvency by 2030, according to a statement on its web site.
Joshua Rauh, an associate professor at Northwestern University’s Kellogg School of Management co-authored a study on public pensions that asserts deeply underfunded state pensions, among them TRS, are heading toward insolvency unless major reforms are enacted. Rauh testified before Congress that state and local governments need to increase their funding, some pension benefits need to be frozen and pension funds must stop assuming they're going to achieve their stated annual investment return targets (such as TRS' 8.5 percent assumption).
Meanwhile, TRS was reported to have the fourth riskiest investment strategy in the country, because 81.5 percent of its portfolio was not in secure cash or cash equivalent assets, according to trade magazine Pensions & Investments, which released its survey in 2010 and based the conclusion on 2008 fiscal year information.
In December, a Crain’s Chicago Business article raised questions about whether TRS was becoming too aggressive by buying into more "alternative" investments such as hedge funds and private equity as it sought to attain the 8.5 percent annual target return. In response, the state’s Pension Investments Committee, headed by House Republican Leader Tom Cross (R-Oswego), is reviewing investment strategies for TRS and other major state funds, according to a Cross spokeswoman.
To be sure, TRS’ stock and bonds also were hit hard by the market turmoil of 2008 and 2009.
Almost every fund or investment vehicle managed by TRS’ top 10 vendors posted double-digit losses in fiscal 2009.
But outside industry experts say even when taking the 2008 and 2009 market downturn into consideration, TRS is not getting a big enough return for the amount of money it’s spending on financial adviser fees.
For instance, another large pension for public employees in Illinois was better able to navigate the financial crisis while paying less in fees than TRS.
The Illinois Municipal Retirement Fund (IMRF), which had $24 billion in assets at the end of 2010, had an average annual return of 5.4 percent (not including fees) for the 10-year period ending in 2010. The fund couldn't provide a net return for the 10-year period.
During that period, IMRF paid $594 million in fees to money managers, significantly below TRS’ $1.4 billion payout. Eighty vendors were paid more than $1 million each by IMRF.
"I don’t know how they’re (TRS) paying fees like this," says Dale Rosenthal, assistant professor of finance at the University of Illinois Chicago. "This is so off the charts, they should be making magic for that kind of money. People should be talking about TRS" as a model for investing.
BGA consultant Zettler, who has openly advocated for public pension reform and overhauling the system, said investment advisers should reap sizable fees only when investments are performing well and take less when they falter.
"The solution is some kind of pay for performance," Zettler says.
In its statement, TRS said its "investment management fees are competitive, and often superior, to public pension plans of a similar size."
TRS said it follows no formal guidelines dictating whether fees will be paid on an asset-based or performance-based model. The pension fund’s investment staff negotiates the fee structure individually with each money manager; the TRS Board of Trustees approves all fee agreements.
Indeed, some other state funds are paying higher fees. For example: the Pennsylvania State Employee Retirement System spent $1.3 billion over the past five years for a 3.6 percent return.
Still, other state funds are now aiming to drive down their fees and reduce their number of vendors:
The State of Wisconsin Investment Board (SWIB) is attacking fees linked to managing its $70-billion-plus pension, whose main fund also posted a 3.7 percent return for the 10-year period prior to June 30, 2010.
Since 2007, SWIB has been reducing its number of outside investment firms and developing an in-house management team, an approach that has yielded annual savings that "exceeds $26 million and is growing", according to the system’s 2010 annual report.
In calendar year 2010, the $77 billion pension fund spent $207 million on fees to external investment advisers—about the same amount as TRS, which had a much smaller $31 billion in assets that year.
New York state’s Cuomo Administration recently launched an investigation after public pension fees spiked 163 percent from 2007’s $167 million, even as annual returns dropped.
California’s giant $242 billion state pension fund, CALPERS, is pushing its managers to lower fees, reduce the number of outside managers and lower costs after its fees recently grew to $1 billion per year.
TRS also disputes claims that its returns for 2001 to 2010 are subpar, noting that the average annual return over 30 years is about 9 percent.
"Any opinion about TRS investment practices measured against a specific 10-year period of history is very limited in depth and does not recognize that TRS is a perpetual entity that looks beyond 10-year periods of time," the pension fund said.
And like four other major state-backed employee pensions, TRS does have an ace-in-the-hole: Under the state constitution, Illinois taxpayers are ultimately responsible for making good should these funds ever go bust.
Robert Reed is the BGA's Director of Programming and Investigations. Brett Chase is a Chicago-based freelance reporter and BGA investigator.