When Wall Street Gets Paid Money For Doing Absolutely Nothing
Private equity managers charge lavish fees on committed, uninvested capital because sheepish investors let them.
Private equity managers charge fees on committed, uninvested capital because sheepish investors—including massive state and local pensions overseen by fiduciaries—let them.
Question: What’s better than getting paid 1% to manage people’s money?
Answer: Getting paid 2% to not manage it—for doing nothing.
In certain niches of the money management industry it is common practice for managers to charge (and investors to pay) fees—typically 2%—on money merely committed to a venture—money the manager does not even manage yet.
This amounts to adding insult to injury since these types of alternative investment funds already charge exponentially higher fees than traditional stock and bond managers.
In 2017, reportedly fees on committed, uninvested capital were the norm in private equity funds. That is, 91% of private equity managers demanded investors pay fees today on money investors had committed to invest over time, say, over the next 10 years.
In my opinion, there is no justification for these bogus fees that virtually all private equity managers charge, and investors pay without objection.
When, in my forensic investigations, I bring hundreds of millions in fees paid on committed, uninvested capital to the attention of supposedly savvy institutional investors (aka fiduciaries overseeing other people's money), initial disbelief and embarrassment swiftly turns to defensiveness.
For example, included in my forensic investigation of the State Teachers Retirement System of Ohio was the shocking finding that the pension paid an estimated $143 million in fees on committed uninvested capital.
That’s an awful lot of money for doing nothing—indeed, it was enough to restore the COLA benefit that had been taken from teachers to 2 percent. STRS Ohio’s experts defended the lavish payments, claiming paying hundreds of millions to Wall Street for doing nothing was no different than paying teacher salaries over the summer months! Ohio teachers were justifiably outraged!
When these payment schemes are exposed to the public, pension officials (victims) and Wall Street (perpetrators) quickly agree there’s nothing wrong with underfunded pensions paying hundreds of millions to Wall Street for nothing.
Victims and perpetrators quickly agree there’s nothing wrong with failing pensions paying hundreds of millions to Wall Street for nothing.
Private equity managers charge fees on committed, uninvested capital because they can—because they’ve convinced sheepish investors these funds will produce stellar returns.
Here’s what State of Ohio Auditor Keith Faber had to say about the practice in his Special Audit of the STRS pension—an investigation prompted by my forensic review:
“The STRS Board could adopt (emphasis added) a new PE investment policy where they only commit capital to investment opportunities that have already been identified. While these deals would eliminate paying fees prior to investing cash, they would also limit the deals to which STRS had access. There are trade-offs in any investment strategy and both the current or hypothetical approaches could be reasonably supported or criticized. As long as management makes a knowledgeable decision and are transparent with the Board, these decisions are within management’s discretion.”
Agree to pay Wall Street $143 million a year for doing nothing, or risk losing out on the best deals? According to Faber, that’s intelligent investing.
An intelligent investor focuses on fees because, unlike performance, fees are the one thing the investor can control.
On the other hand, many so-called "sophisticated" investors don’t focus on, or give a damn about, fees. They will pay anything if they believe a money manager is going to make them big money.
Ironically, I have observed that the more underfunded a pension, the more willing it is to pay outlandish fees—to gamble itself out of a hole.
As we saw in Madoff, many investors, even today, can be persuaded they’re lucky to have their money managed by the priciest gunslingers.
So, the lesson is, if a money manager's sales pitch is good enough, he can even get away with outrageously high fees for doing nothing.
The sky’s the limit.
