Kentucky Retirement: we’re doing nothing wrong with fees

Recent reports criticising the Kentucky Retirement Systems (KRS) for paying investment fees significantly higher this year than previously reported aren’t getting the full picture, KRS chief investment officer David Peden told Private Equity International.

Peden said that the KRS, which consists of five different pensions, changed its accounting method between fiscal years 2014 and 2015, and that accounted for the jump in fees paid.

Local press reports said that a year on from promising greater transparency over what it pays investment firms, the KRS’ annual investment expenses were up 75 percent for fiscal year 2015, which reports claimed were largely due to fees paid to private equity firms.

Although 2015 investment expenses, including the pension and insurance funds, totaled $108.3 million and 2014 expenses were $62.4 million, the different methods used reflect the jump, Peden said.

Peden told PEI that in 2014 the system used an equity method of accounting, which he claimed did a better job of capturing carried interest and other performance-related fees. This year the system used ‘proportional consolidation,’ an accounting method that adds a partially owned company’s revenues, expenses, assets and liabilities to the owner company’s income statement and balance sheets.

KRS released a CEM Benchmarking consultant’s report last month showing the pension fund pays more in investment costs than its peer group for equivalent investments. The disclosure was made at the KRS board of trustees meeting at the beginning of September.

“It’s not that we’re doing anything wrong,” Peden said. “A lot of the numbers in [the CEM report] are fees, sure, but in some cases opportunity costs are included, and many are adjusted in order to capture an apples-to-apples comparison to our peer group.”

The CEM Benchmarking report said the KRS had a “higher cost implementation style” in 2014, meaning their choice of investment is more expensive. This, Peden said, is because the KRS used fund of funds instead of direct investments.

“Our direct investment program is being built and getting to the first stage of the program,” he said. “It’s an ongoing effort but, by the time we get to the end of 2016, we should have greatly reduced reliance upon fund of funds.”

KRS currently allocates 10 percent of its $15.67 billion of assets to private equity, on par with its target, but Peden said he expects the allocation to decrease.

“Two of our pensions are some of the worst-funded in the country,” he said. “Both of those can’t tolerate the illiquidity that comes with private equity so the targets for those systems will most likely go from 10 percent to 2 percent.”

He noted the aggregate allocation of all five systems will probably fall below 10 percent, but not as drastically to 2 percent.

When asked about the initiative from the Institutional Limited Partners Association to develop a fee reporting template, Peden said, although KRS is not a member of ILPA it certainly encourages any industry partner seeking to improve fee transparency.

“There almost needs to be a third party like the ILPA to step in and create a standard so everybody’s doing [fee reporting] the same way,” he said. “As much as we hate it, we get compared to our peer group, which is silly because we all have different liabilities and asset allocations.”

As of 30 December 2014, the KRS had commitments to 73 private equity funds with a total market value of $3.23 billion. It committed $100 million to DB Secondary Opportunities Fund III, $60 million to BDCM Opportunity Fund IV and $40 million to Ares Special Situations Fund IV, all in 2014, according to PEI’s Research & Analytics division.”

A group of public employees in Kentucky is suing the Kentucky Teachers’ Retirement System and a group including KKR, The Blackstone Group, The Carlyle Group and Rockwood Capital claiming mismanagement of their pensions, illegally raising teachers’ contributions to the system and improperly raising KTRS’ exposure to private equity.