
NYC Pension Earns $40M Over 10 Years, Pays Fund Managers $2B - arielm
http://thereformedbroker.com/2015/04/09/nyc-pension-earns-40-million-over-10-years-pays-fund-managers-2-billion/
======
bjourne
It's what has become of capitalism. First there were producers, they sold what
they created themselves and made a profit. Then there were merchants who
bought and sold and made a profit on the difference. Then investors who
invested in merchants and made a profit by collecting interest on lended
money. Nowadays, it's the fourth level of capitalists, the fund owners, who
takes peoples money and invest it into investors who then invests it into
merchants.

A common scam is to email 10000 people betting picks. To half of them you
predict that team A will win and to the other half that instead team B will
win. Repeat the process with the ones who got the right picks and after a few
iterations you have a small group of gullible people who think you have
supernatural sport prediction abilities.

Fund managers do the same thing all the time. They have a portfolio of funds,
some of which purely due to chance will not beat their market line and will
then be folded into those who did. Then new funds are started to fill the
void. This way, almost every fund can appear to beat the market average.

That's just one of the many tricks available to fund managers. Another is
choosing the right index to compare your fund against and selecting which time
period puts it in the most favorable light. Maybe the performance over the
last three years were extra strong or maybe it had a dip so let's compare over
the last seven years instead?

The worst thing is that you can't abstain from playing the game. Your
retirement money is on the stock market and fund managers will take a big
slice of it in fees whether you like it or not.

~~~
kasey_junk
> The worst thing is that you can't abstain from playing the game. Your
> retirement money is on the stock market and fund managers will take a big
> slice of it in fees whether you like it or not.

What are you talking about? There has never been a time where investing was
cheaper and there were more options to invest without a fund manager getting a
slice.

If you want to discount your pension benefit because you don't control the
asset allocation (and I think you should, but that is an opinion) that is
fine, but it isn't some sort of "rigged game" that you don't have options in.

~~~
bjourne
Most of us doesn't have any disposable income to directly invest. Instead we
have indirectly become investors thanks to the part of the salary set aside
for us in the form of taxes and payments to pension plans. I don't have the
numbers, and it differs from country to country, but it's a huge chunk of your
salary. Like ~20% of your gross income is used to finance your retirement
because you might live several decades after you retire.

The Swedish system (totally simplifying here) works so that once a year you
get to allocate about half your tax collected savings to a list of funds
selected by some government officials. Another part of your pension if paid by
your employer through a pension broker and again you can select among a list
of approved funds. All of the funds you can choose from charges a hefty fee to
manage your capital.

Had I had the choice I would have withdrawn all my money and paid of my home
loans which would have given me a completely risk free return of 3%/year.
Instead I can only choose among these funds whose fund managers managed to
grease some government official enough to put them on their approved list.

~~~
kasey_junk
In that specific case, you do seem to be trapped, and I too would be
frustrated about that, but it seems like you have the trapper wrong. The
financial markets are providing the cheapest investment options ever, but your
representative government is taking that away from you.

I'm not even willing to say that is a net bad thing (there may be all manner
of benefits that come along with it), but place the blame where it belongs.

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chollida1
I'll be honest and admit this is one area where hedge funds do get gready.

Most funds work on a model of 2 and 20, meaning they take 2% of assets they
manage to run the fund and then take 20% of the profits as their compensation.

This works when you manage 100 million as the 2% can cover most costs, but
gets absurd when you manage 100 billion. In cases like this the 2% gets
absurdly big and you just can't hire enough people or buy enough tech to eat
up this money. It becomes free profit, and that is borderline abuse.

The idea with hedge funds originally was, we think we can beat the market and
we only get paid when we do, out of the 20% of profits that we take.
Essentially we are betting on ourselves and we eat only when we do well,

With 2% of 100 billion, it turns out you get paid no matter how well you do.
Venture capital funds are equally bad in this regard:(

Pension funds need to be better about negotiation fees.

 __EDIT __Someone asked me what to look for when investing in a hedge fund.

There are really only 3 things:

1) fees, 2 and 20 is standard and if you are investing a "small" amount, less
than 20 million, you should expect to pay this.

2) lock up time. Generally you should be able to redeem at the end of any
month with 20 days notice, ie if you want to redeem for May 1st, you need to
inform them by April 10th. No fund should be able to lock your money up for
more than a month, though some will try.

There is an exception for this in funds that by definition invest in illiquid
assets, such as venture capital or real estate that can take a year or more to
mature, but even then 90 days is absolute max you should tolerate. ie if a VC
tells you you are locked up for 5 years, and some will, you should tell them
thank you and move on.

3) track record. Don't invest in any hedge fund less than 5 years old, unless
you have special knowledge or a healthy risk appetite. Its just not worth
giving someone else the chance on your dime. Most new funds are started by
people leaving a fund and if they are good they get seeded by their previous
fund, friends and family. Make them prove themselves before you put yoru money
into them.

~~~
no_wave
4) If you're investing any "small" amount, don't invest it in a hedge fund.
Invest it in a passively managed (index) fund. I pay .3% a year on my assets
and get market returns.

~~~
vonmoltke
Move over to Vanguard. I pay 0.05% for American stock index funds. In fact,
all of their various stock index funds are less than 0.3%.

~~~
koyote
Put you still end up paying around 0.2%-0.4% in platform costs. Or is this
different in the US?

~~~
mahyarm
The most expensive ETF I use in vanguard is %0.15. Past the expense ratio for
the ETFs I pay no fees.

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jongala
Can someone clarify this? Because the article explains:

> "Over the last 10 years, the return on those “public asset classes” has
> surpassed expectations by more than $2 billion, according to the
> comptroller’s analysis. But nearly all of that extra gain — about 97 percent
> — has been eaten up by management fees, leaving just $40 million for the
> retirees, it found."

Note "surpassed expectations" in there. That makes it sound not like the
_total_ return was $2B but that the return was $2B above projections, and
after fees this was functionally erased leaving return at projected level. Am
I misunderstanding the language here?

~~~
mynameismonkey
My read is that the fund managers created an additional $2B in exceeded
expectation/value, then billed 97% of that created value. In other words, stay
home, don't use these guys, don't pay them $2B, get the same returns. That's
how I understand the point.

~~~
jongala
Yeah that's how I'm reading it but then I guess the question then becomes
whether the projections were made specifically with a hedge fund strategy in
mind or if they would have been the same for a more conventional investment
approach.

I'm not trying to discount the take-away that the fees are very high
regardless of the projection basis, but I think it's important to understand
the difference. If these criticisms are not clearly reasoned or communicated,
I think that fuels the perception in the financial community that these
complaints are hysterical and unfounded and should be dismissed.

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scott00
Primary source: [https://comptroller.nyc.gov/newsroom/comptroller-stringer-
bi...](https://comptroller.nyc.gov/newsroom/comptroller-stringer-billions-in-
pension-fund-fees-paid-to-wall-street-have-failed-to-provide-value-to-
taxpayers/)

The wording of both primary and secondary sources doesn't make the facts
uncovered by the analysis particularly clear, IMO. Based on my reading, these
are the facts:

* Managers of public investments (public stocks, bonds, etc) outperformed their benchmarks by at least $2.1 billion before fees, and charged at least $2 billion in fees. Fees were at least 95% of excess returns, but less than 100%.

* Managers of hedge funds, private equity funds, and real estate investments underperformed their benchmarks after fees by $2.6 billion. Amount of fees is not stated.

~~~
rbcgerard
That's the way I read it, heaven forbid they provide the actual report.

Also, if we assume 80% of the $160 billion is in public investments that
achieved their benchmarks net of fees over the past 10 years $2b in fees seems
pretty reasonable at 0.16% ((2 billion /10 years)/(160*.8))

------
chrisa
The question which isn’t answered in the article is: how would the fund have
done if passively invested in the market? If the market lost money over the
same time period, then although extremely high, the fees are a relatively
"good deal" (since the fund was up $40M, and the alternative would be losing
money). If they’re talking about the last 10 years however, it looks like the
market should have returned about 70%, which makes the fund manager's
performance look even worse.

~~~
totalrobe
S&P 500 returned about 92.09% from 2004 - 2014.

They referenced it being a 160 billion dollar fund so they really should have
been looking at returns of closer to 100 billion...

[http://ycharts.com/indicators/sandp_500_total_return_annual](http://ycharts.com/indicators/sandp_500_total_return_annual)

*although if all large pensions/trusts/endowments were passively invested in the market, some of these financial companies on the s&p list would not have been able to steal so much from pensions so i'm wondering what type of effect that would have had on total market returns

~~~
encoderer
Nice try. $SPX is not where you want $160bn of _pension money_. 10% maybe,
with similar investments in treasuries, commodities, cash, etc.

~~~
bradleyjg
I somehow got downvoted for pointing this out yesterday, but with target
return rates of 7-8%, pensions can't invest in what most of us would consider
a prudent portfolio. At least not in a low inflation environment (since
targets seem to all be nominal rather than real).

While I would agree that a pension fund shouldn't be in all equities (or
investment with similar risk profiles) if the fund managers are mandated to
target 7.5% returns its hard to see how they can include a sizable cash or
treasury component and expect to hit that.

~~~
encoderer
Leverage

------
uptown
Here's the original story:
[http://mobile.nytimes.com/2015/04/09/nyregion/wall-street-
fe...](http://mobile.nytimes.com/2015/04/09/nyregion/wall-street-fees-wipe-
out-2-5-billion-in-new-york-city-pension-
gains.html?ref=nyregion&_r=1&referrer=)

~~~
tnb234
Non mobile version : [http://www.nytimes.com/2015/04/09/nyregion/wall-street-
fees-...](http://www.nytimes.com/2015/04/09/nyregion/wall-street-fees-wipe-
out-2-5-billion-in-new-york-city-pension-gains.html)

------
math
Related: The best study I'm aware of that attempts to estimate the
distribution of fund manager skills is this one by Fama and French (of 3
factor model fame) from 2009:
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021](http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021)

~~~
watmough
You are missing the wood for the trees.

The real skill is collecting 2.5 billion in fees, for essentially no value
added.

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robdimarco
My county recently changed to using a passive investment strategy for pensions
and there is a push for the whole state of PA to change to a similar model.

[http://www.philly.com/philly/opinion/inquirer/20150301_Follo...](http://www.philly.com/philly/opinion/inquirer/20150301_Follow_the_Montco_model_on_pension_reform_and_save_billions.html)

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downandout
These results actually make sense. The 10 year period covered a tumultuous
time in our economy. When the market drops 20%, no fees are paid, but no
breaks on future fees are offered either. So let's say they start with $100
billion. The fund loses 20% one year, then rebounds exactly 20% the next. If
charging 20% of profits, $4 billion in fees are paid on the $20 billion
"gain," even though investors made nothing. They've actually had a net loss of
$4 billion after paying fees on their "gains".

That is primarily why these numbers seems so ridiculous - the market had a few
bad years, and then came back around. The people in charge of deploying this
money should negotiate better terms, like paying fees only on _net_ returns
over longer periods of time (5 years instead of one year, for example). At the
end of the day, it's their own fault for cutting lousy deals. $160 billion
gives you a pretty big bargaining chip on fees.

~~~
VikingCoder
> At the end of the day, it's their own fault for cutting lousy deals.

Victim blaming. Well done.

~~~
downandout
Oh please. If you're in charge of $160 billion, you better be one of the most
sophisticated investors on the planet, and wield your extraordinary power to
achieve the greatest returns for your stakeholders. Those fee agreements are
clear as day. They should know precisely what can happen if they choose to pay
fees on yearly gains instead of on net gains from inception.

Stupid people aren't victims; they're just stupid. The bankers had a
responsibility to their shareholders to ask for the highest fees possible, and
the managers of the $160 billion had a responsibility to say no. Looks like
the bankers did their job.

~~~
VikingCoder
Well said. Honestly.

So, let's play out the theories:

1) The pension managers WERE some of the most sophisticated investors on the
planet.

So what the hell happened? You originally called them "irresponsible." Now
you've edited to call them "stupid." What's your theory about what happened to
these world-class investors? My point being, they can't simultaneously be in
the "most sophisticated" class, and also in the "irresponsible" / "stupid"
class.

Kickbacks? Got overly greedy and mis-fired? It could happen to literally
anyone? Bad luck?

2) The pension managers WERE NOT some of the most sophisticated investors on
the planet.

I agree with your assessment that they SHOULD HAVE BEEN. So what the hell
happened? Did they lie when they were hired? Did they have a great track
record (luck?), but flubbed this? Or did the person who hired them and put
them in charge (the mayor?) trust someone they shouldn't have?

The real victims are the pensioners, and this story should be investigated. If
not on their behalf, then as a lesson for other pensioners, pension managers,
and the people who manage pension managers.

~~~
downandout
I edited it because "irresponsible" wasn't strong enough in this case. What
they did was idiotic. I think they were on the stupid side...with this kind of
money floating around, any hint of kickbacks or corruption would quickly float
to the surface. I'm sure that the funds they invested in were run by world
class investors, but the pension manager(s) simply didn't understand the
implications of the fee agreement.

~~~
VikingCoder
Again, they can't simultaneously be in the "most sophisticated" class, and
"idiotic."

Unless your assertion is "even the most sophisticated investors can be
idiotic."

I'd say "idiotic" should be upgraded to "colossally idiotic." $40M earnings on
$160B in 10 years?

So, what do you think?

~~~
downandout
I don't think that the pension managers were sophisticated, but rather were
idiots. They went to world class bankers to deal with the money, who did a
world class job of creating an awesome fee structure for themselves.

~~~
VikingCoder
So then who put idiots in charge of a $160B pension? And why did they do it?

Not expecting an answer from you - I'm saying these become the questions I
want answers to.

------
Animats
This is why pension funds should not be treated as "sophisticated investors",
allowed to invest with unregulated hedge funds. The overall performance of the
hedge fund industry is on a par with the results here. Most of the returns go
to the fund managers. Why anybody invests with those clowns is unclear.

Pension funds, as a class, cannot beat the market. They _are_ the market. They
should be in index funds and bond funds with very low management fees.

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icedchai
They should've used Vanguard. ;)

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littletimmy
Sooner or later, investors will wisen up to the fact that hedge funds are not
an asset class; they are a compensation scheme.

Who makes the decision to put pension funds into hedge funds anyway? This is
just filtering away money from poor people, who would have seen better returns
from an index fund. Disgusting and obscene.

~~~
kasey_junk
> Who makes the decision to put pension funds into hedge funds anyway?

Pension fund managers. They are often also well compensated for this decision
making process. Many, many hedge funds and ibanks spend as much time/energy
courting pension fund managers as they do generating returns.

This is because the customers of the pension (the people that will want the
benefit) are largely a captive market and are frequently unsophisticated
financially. Its one of the many reasons I will not take a job that uses
pensions as a benefit (and am baffled when unions fight so hard to keep them).

~~~
pkaye
Public unions like pensions because they are defined benefit plans and are
guaranteed a specific monthly benefit. The risk is passed to the tax payers
because they need to cover any poor investments.

~~~
kasey_junk
Let me rephrase. I don't understand why union members feel comfortable
trusting a large portion of their employment benefits to the whims of the
legislatures or much more rarely now, private companies, that "garauntee"
them, nor to the capabilities of the pension manager. The downside of lack of
mobility, lack of choice, and poor performance all seem like they would be
deal breakers to me, but again, I've never worked in a pension system.

Defined benefit plans can of course be had without using a pension so that
seems a red herring.

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evanpw
This article is pretty garbled. Matt Levine is, as usual, excellent:
[http://www.bloombergview.com/articles/2015-04-09/new-york-
di...](http://www.bloombergview.com/articles/2015-04-09/new-york-discovers-
wall-street-charges-fees)

------
tinkerrr
The New York Times article seems to be talking about the _extra_ gain, which I
presume means gain in addition to beating the benchmark. Here's the quote:

"Over the last 10 years, the return on those “public asset classes” has
surpassed expectations by more than $2 billion, according to the comptroller’s
analysis. But nearly all of that extra gain — about 97 percent — has been
eaten up by management fees".

I read this as meaning that the _extra gain_ meaning gain minus benchmark gain
was $2B and most of it was eaten by fees (which is still bad, but not as bad
as the article and its title seem to suggest).

~~~
vasilipupkin
I don't think that's correct. For example, the article says

Until now, Mr. Stringer said, the pension funds have reported the performance
of many of their investments before taking the fees paid to money managers
into account. After factoring in those fees, his staff found that they had
dragged the overall returns $2.5 billion below expectations over the last 10
years.

~~~
tedunangst
There appear to be two uses for the word "expectations" here, for two
different things. There was the original expectation that the fund manager
promised, that was exceeded. Then there's the expectation of what NYC would be
able to withdraw, which failed to account for fees.

Expectation A: Fund value will be X. Reality: Fund value is X + 2b.

Expectation B: NYC can cash a check for X + 2b. Reality: NYC only gets X +
40m.

The reporting isn't very clear, IMO.

~~~
vasilipupkin
Agree. Reporter did a poor job. I would think the expectation should be the
relevant benchmark, meaning, passive portfolio like Vanguard invested in
similar proportions of stocks and bonds.

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coob
Isn't this true of most actively managed funds?

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encoderer
This is why I believe people who think you can just sock money into a "low
cost index fund" and never think twice about it are misguided. Even if you end
up with _most_ of your money in said low-cost index fund, it's important to be
engaged, informed and educated.

~~~
sukilot
How so? The article shows how NOT using an index fund hurts.

~~~
encoderer
Rather, I think the article is showing us how not being informed hurts. It
took them 10 years to understand what was happening with their money?
Unacceptable.

Learning how investing works, breaking out of the pie-chart bs sent to you in
your nice quarterly statements and really understanding how your money is
invested.... Like i said, I don't have an opinion on where you put your money
but I think the idea that you can hand it over and never think twice because
you're in a low-cost fund is misguided.

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abhigupta
This translates to net annual return of 0.0025% :)

------
coldcode
If they had simply used a dart board or other randomized device, I bet they
would have made the same $40M but saved the $2B.

