TREASURER LOFTIS featured in Wall Street Journal about Private Equity Shortfalls

Pensions’ Private-Equity Mystery: The Full Cost
Public pensions are owning up to a painful truth about their private-equity bets: They never totaled the bill
By:Timothy W. Martin
From: Wall Street Journal

Nov. 22, 2015 6:38 p.m. ET - Public pensions are owning up to a painful truth about their private-equity bets: They never totaled the bill.

For years, officials who oversee retirements for teachers, firefighters and other government workers said they failed to either ask or disclose how much private-equity firms kept in performance fees, the biggest source of profits for outside money managers.

Now, pension funds from New York to California are doing those calculations and revealing much bigger sums than they had ever made public. The size of the expenses could mean tougher scrutiny of private-equity investments and more pressure to cut back those holdings or negotiate lower fees.

The California Public Employees’ Retirement System is expected to announce this week that it paid private-equity firms billions of dollars more over the past 17 years than it had previously disclosed, according to people familiar with the situation.

Similar assessments made public recently by retirement systems in New Mexico, South Carolina, Kentucky and New Jersey showed total costs were as much as 100% higher than originally disclosed.

Private-equity firms say they have long provided information about their costs and share of any profits, commonly known within the industry as carried interest. “We provide complete transparency” on performance fees, said Thomas Mayrhofer, chief financial officer of Carlyle Group LP’s private-equity segment. The bigger that number is, “the better because it means we are performing well for our investors.”

Private-equity firms buy companies using money from pension funds and other investors, hoping to earn more in a sale or public offering down the line. They typically charge clients a management fee of 1% to 2% of assets and performance fee of about 20% of the gains when they sell companies for a profit.

Pension funds have long disclosed the management expenses but avoided a calculation of performance payouts because accounting rules didn’t require the costs to be publicly reported and returns were high enough to mitigate any cost concerns.

When pension funds did the math as political scrutiny of these expenses intensified amid a broader debate on the costs of nontraditional investments, they said private-equity firms didn’t make the expenses easy to calculate. No standard existed for how the fees were disclosed to pension funds, if they were disclosed at all.

In South Carolina, pension officials said quarterly financial statements provided by private-equity managers typically didn’t show precisely how the value of the state’s investments had changed or how profits had accrued over multiple years.

The statements also often followed a calendar year rather than the state’s fiscal year, said Andrew Chernick, managing director of operations for the state retirement system investment commission.

That made it difficult to isolate the impact on South Carolina, he said.

In 2013, the South Carolina investment commission asked five full-time employees to search financial-statement footnotes and private-equity investor reports and ask most of its private-equity managers for specific data.

That team eventually concluded the state had spent $418.3 million a year on outside money managers, producing a figure that for the first time could be reported in all of the state’s pension-fund financial disclosures.

The disclosure led to a backlash among South Carolina political leaders including South Carolina State Treasurer Curtis Loftis, who after taking office pushed his state’s pension officials to divulge all investment-manager costs.

“The underreporting of fees was an open secret, and nobody was talking about it,” Mr. Loftis said.

Other states have jumped on the same issue as they seek to cut ties and reduce fees with more external money managers.

The New York City Pension Funds, the nation’s fourth-largest retirement plan, sent a letter to outside money managers last month demanding they deliver full transparency on fees and expenses—or be dropped from its portfolio.

But not all pension officials are blanching at the bigger disclosures, largely because the underlying bets have been so profitable.

Over the past decade, private-equity investments outearned all other pension-fund holdings with an annualized 11.9%, compared with 7.7% for real estate and 7.1% for stocks, according to the Wilshire Trust Universe Comparison Service.

Looking at the performance fees alone without accounting for returns “is a bit like referring to Reggie Jackson as the all-time strikeout leader without saying anything else about him,” said Tom Byrne, chairman of the New Jersey State Investment Council.

The profits collected by private-equity firms “is not a number that’s really meaningful to me,” said  Gary Bruebaker, chief investment officer at the $78 billion Washington State Investment Board. “I hope all of my private-equity partners get rich,” he said, “after my members get really rich.”

Calpers began its own calculations earlier this year after a senior official acknowledged at a board meeting the staff couldn’t produce a private-equity profits total.

“When they first said they didn’t know the number, I thought they were lying,” said Calpers director JJ Jelincic, who asked for the information. “It was inconceivable they would not know.”

Scrutiny of the issue intensified after a blog Naked Capitalism publicized the exchange between Mr. Jelincic and the Calpers official. One board member, California Treasurer John Chiang, has since asked for a state law that would require the disclosure of all private-equity fees.

“There is a gaping hole that needs to be explained,” he said.

Write to Timothy W. Martin at