Public Pensions Band Together for Lower Fees

Small-to-medium sized public pension plans looking to access private equity face obstacles in the form of high fees and a lack of the negotiating leverage that larger LPs enjoy. A customizable fund-of-funds platform pioneered by Pantheon and the chief investment officers of public pension plans in California addresses those problems, with lower fees, based on invested, rather than committed, capital.

In March, a selection committee chose Pantheon to manage a collaborative fund-of-funds platform with a bundled, flexible approach for the Orange County Employees Retirement System and other participating public pension plans in California.

The chief investment officer of OCERS, Girard Miller, was key in collaborating with CIOs from other counties’ plans during the months-long process of selecting a manager and formulating an approach.

Miller explains why OCERS chose the bundled fund-of-funds platform over going it alone with a single firm like KKR.

“A major problem in private equity with plans of our size is the economics are very different for investing directly,” he says.

OCERS is an $11B cost-sharing, multiple-employer defined benefit pension plan. In a direct investment situation, a fund of OCERS’s size would be “at the back of the line for the most sought-after investments,” says Miller.

There are several counties’ plans involved in the bundling with Pantheon—San Bernardino County Employees Retirement System is the only other plan whose CIO’s identity was—with $300M to $1B of investment guaranteed per year for the next three years. OCERS has committed $100M to Pantheon in 2014, with another $50M to $100M penciled in for the following two years.

The total bundled amount, and number of pension plans involved, was not greater because of potential anti-trust limitations and fears about dilution of returns given any single management firm’s capacity.

When Miller was hired by OCERS in 2012, he began asking why no one was doing this sort of collaborative investing. Reasons included getting pension plan CIOs on board—“it’s herding cats,” Miller says—and that it was too much work. Another issue was anti-trust liability, he says, calling it a “bugaboo that’s been around for a couple of years.”

Finally, at an annual conference of CIOs from California counties, he started talking to his peers and the working group decided that the “low-hanging fruit for us was the private equity space.”

Miller and several other CIOs spent three to four months on conference calls to put together the term sheet. In December of 2013, a request for proposals was put out, and there were 14 respondents from the private sector.

To satisfy the other CIOs in on the process, best-in-class criteria was established for manager selection, Miller says. Cost—including fees and the fee structure—was a factor, along with best value, portfolio performance, and product flexibility and fund/platform architecture suitable for use by a diverse community of public pension plans. The field was eventually narrowed to three finalists.

“At the end of the day, it wasn’t the lowest fees, but the best returns net fees,” he says of what Pantheon offered that helped win over the judges.

The firm also offered extensive access to the industry globally at the board level, with 270 advisory board seats, and having more than a one-size-fits all approach.

“We figured we’d have to have the training wheels product,” says Miller. “But all of the firms that came in and made it to the semi-finals and finals had some flexibility. Generally speaking, however, the design was the traditional fund-of-funds model.

“The special sauce that Pantheon has developed is a partnership that gave us granularity down to the general partner level.”

The flat fee structure with no carry charge was also an attractive part of Pantheon’s proposal—and an unusual one. There was a requirement of all finalists to quote their fees on invested capital, rather than committed capital as is the norm.

The proposed fees from Pantheon will result in a roughly 50 percent reduction of fund-of-funds investment management costs from what OCERS is now paying its managers. The level of savings depends on whether they decide to fund the full $100M each year or not. According to a press release, the cost savings for OCERS “should exceed our investment division’s entire personnel budget.”

“The outcome was actually much better than what the original CIO working group envisioned,” Don Pierce, CIO of the San Bernardino County Employees Retirement System, says in a press release about Pantheon’s selection. He was a member of the team who came up with the bundled platform and the review panel that evaluated proposals.

While San Bernardino County has been disclosed as a participant, it doesn’t bind the public pension plan’s trustees to being a buyer, says Miller, adding, “It’s a bundle, not a pool.” All of the CIOs from participating plans will go through their own internal decision process.

The weeding out of potential managers took four months from the request for proposals to selection of Pantheon.

“Pantheon exceeded our expectations, and we’ve made real headway in achieving collective bargaining power through this process,” Miller says. “The cherry on top is the guidance we’ve gained from our anti-trust legal opinion, which I consider one of my career achievements for the clarity it provides to the public pension community.”