NuclearPhynance Archive

"CalPERS have planned to pay fund managers on a performance only basis because of underperformance in a move that could potentially shake up the industry."



Full story here.



If this does indeed become a trend, I know more than a few folks that may be forced to find a new line of work...

For those who don't know, CALPERS (at least when I talked with them) also paid their portfolio managers very poorly at civil service type rates.  You could end up managing a huge amount of money there, but as you leave work at night you have to hop into your 1995 Hyundai Sonata with bald tires praying you don't have a flat on your trip south on the 99.

Same thing with any state pension-"ish" fund.  The Pennsylvania Pension Fund is one of the largest and most well-respected in the business, and after a couple of rounds of interviews there they threw a number at me that was difficult not to laugh out loud at.



"So I'd be responsible for XXXXXXXXXXXXXXXXX dollars and you're going to pay me x dollars?"



Unfortunately, no one's going to get rich working for the government.  Bush only makes $400K.

Skillionaire: Bush only makes $400K



Well, yes... but there is "payment for order flow".... Smiley



Anyway, getting back to the topic, I personally think they should have done that 50 years ago. There's way too much driftwood in asset/fund management. It's about time people stopped getting paid for LIBORish return profiles.



(Note that we don't charge a management fee. So... I guess I'm biased. *shrugs*)

Sure but my thought was more about the numerous funds that are doing quite well just collecting their 2% management fee, while they struggle to produce much, if anything, beyond their benchmark.



Edit: Crossed with FDAX.

For whatever reason I was expecting something a bit more shocking than no fees for non-alpha generating managers.  It's not like it's a total coup to not pay someone who lost your money (or more appropriately didn't use your money effectively).  You could easily do it just by allocating away from those that underperform.

It's not enough to remove allocation. Imagine you give manager Y 100 dollars. After a year, he's down 20%. You obviously take your money out. But the manager will hit you for 2% on top of that (assuming it's yearly based). Now you're down 22%.



And yes, there are people that have the gall of charging you 2% after they lose 20%. Seen it.

Won't this scare a lot of people away?



Wouldn't it make more sense to do what some hedge fund managers do, where losses have to be covered in future years before any compensation (other than the yearly fixed fee)?



If you're managing that much money for the government, you deserve to get paid more in years you do well, and still deserve something for bad years for working for the government.

"And yes, there are people that have the gall of charging you 2% after they lose 20%. Seen it."



I've seen it too and I agree it's galling.  My point is that they should be focusing more on where they allocate.  Paying no fixed fee just makes the number you have to subtract from returns as base fees zero.  For the reasons that sfca listed below, investment inertia is overwhelming at pension funds in my experience.

"If you're managing that much money for the government, you deserve to get paid more in years you do well, and still deserve something for bad years for working for the government."



And this is the difficulty when we assume a Markowitz model and then define alpha space, and *also* assume that alpha is generated at the capital allocation level rather than at the front line battle with the market. This is the “Generals win battles” idea over the “sharpshooters at the front lines picked off more of them than they did of us” theory.



The trouble comes from the investment specialization within a weighted market portfolio (which is what state pension funds assume they are). You have to have someone trade gold, hards, softs, front end, long bond, corporates, real estate, equity, etc. and these folks specialize.



Gold is on fire right now, but the guy in the Arkansas State Employee Pension fund who manages their gold portfolio had about nothing to do with either 1) the AUM the allocation committee gave him, or 2) how hot the market is. He is paid the same as the guy who manages the Asian Equity allocation.



Putting State Pension Fund employees on the pay-for-alpha scale creates some problems….namely they have to then internally lobby for AUM/allocation size promising future alpha. Paying them a percentage of the alpha they generate is all well and good, but the real battle is for AUM because different asset classes, by their very nature, have differing expected return spaces.



For example: the expected return of Investment Grade corporates is so tiny over LIBOR that the IG team or portfolio managers in a State Pension fund actually rationally should spend *all*their*effort* simply to get 100% of the AUM allocated to them, and then just hope the market randomly pays them off. That is their personal utility curve best expected return.



These sort of agency problems for State and Federal employee pension funds have been looked at, and each state does things a little differently. The Texas State Teachers Retirement pension fund managers has actually more internally managed money than the Texas State Employee Pension fund, which mandates out to external managers most of their AUM. The decision is “can we do this cheaper internally or externally?” 



Quick studies probably see the irony above, the Portfolio managers of the Texas State Teachers Retirement Pension Fund are not teachers, but Texas State employees, and their own State pension is run by external managers.



States who have employees have a lot of choices to make, the first being internal versus external managing, and then how you are going to allocate the AUM. Under either model agency problems abound and I’ve only touched on some of them here.



Full disclosure: I was on the short list for CIO of a State Employee Pension fund in the USA. I was not offered the job (went to a Hispanic guy who actually had better credentials than me, but not a better investment track record, but who was also already a resident of the State).



The pay scale was also laughable. This job I did not get offered paid $180k per year, and that was the cap until the State legislature would change the scale.



 



There are a couple kind of folks who are attracted to that job…folks who are smart and lazy…folks with political ambition and it is a stepping stone, …folks from within the organization who want the top slot….or folks who’ve already made a pile and like the intellectual challenge of running a very very large amount of money. Feeling your own size daily in a variety of markets is a very interesting set of problems.