Kentucky Pension Fees Much Higher Than Previously Reported

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One year after promising more transparency in what it pays money management firms, Kentucky’s pension plan for public employees says that its annual investment expenses are running 75 percent higher than reported in previous years.

The disclosure was made last week at a meeting of the Kentucky Retirement Systems Board of Trustees, which operates one of the worst-funded public pensions in the United States. Trustees were also given copies of a consultant’s report showing that KRS’ investment costs were 9.2 percent higher than the benchmark of similarly sized public pension plans in 2014.

In a staff memo given to board members, KRS said that it revised the amounts spent on outside investment firms in the year that ended June 30, 2014, as part of a “proactive transparency change.”

“It did not affect our net income,” said KRS Chief Investment Officer David Peden. “Our net performance numbers were the same.”

Still, the 348,000-plus state, city and county workers and retirees relying on KRS for their pensions now have a more accurate reading of how much KRS pays investment firms, hedge funds and private equity firms to invest its roughly $16 billion in assets.

In its audited financial report for fiscal 2014, KRS showed total investment expenses of $62.4 million. Following reports by the Kentucky Center for Investigative Reporting and the Lexington Herald-Leader last year about undisclosed fee payments, KRS changed its policy to provide greater disclosure. For fiscal 2015, it estimates having spent $108.3 million -- a 75 percent increase -- almost entirely from newly disclosed fees paid to private equity firms. (Read: "When it Comes to Investments, Kentucky Keeps Pension Holders in the Dark")

The attention to investment fees paid by KRS stems from its heavy appetite for “alternative” investments such as real estate and funds investing in oil and gas leases, timberland and leveraged buyouts. Managers of alternative funds generally charge higher fees that eat into returns. As of July 31, alternatives represented almost 35 percent of KRS’ holdings.

Tommy Elliot, chairman of the Board of Trustees, and Executive Director Bill Thielen listen to a presentation during the meeting of Kentucky Retirement Systems on May 15, 2014.

Alix Mattingly/KyCIR

Tommy Elliot, chairman of the Board of Trustees, and Executive Director Bill Thielen listen to a presentation during the meeting of Kentucky Retirement Systems on May 15, 2014.

KRS did not revise its 2014 financials to reflect the change in investment expense reporting. Peden, though, said the 2014 expense figure would have been “similar” to the amount KRS expects to post for 2015.

What remains undisclosed are the fees incurred by KRS’ investments in so-called “funds of funds,” or hedge funds that invest in other hedge funds. Almost 10 percent of KRS’ $16 billion sits in such funds, which are constituted specifically for KRS and cannot be readily sold because they don’t trade in public markets.

The recently released consultant’s report, by CEM Benchmarking of Toronto, states that KRS’ higher-than-average investment expense ratio was “driven mainly” by its fund-of-funds holdings. Because the fund’s five-year net investment return was lower than the median return of public pension plans in its peer group, KRS fell into the “negative value-added, high-cost” quadrant in a CEM graphic of plans.

Chris Tobe, a former KRS trustee who wrote the tell-all book Kentucky Fried Pensions, said KRS has squandered pensionholders’ money by paying high fees for riskier investments with lower returns than unmanaged stock market index funds. He said his reading of the CEM report is that KRS’ investment underperformance of the last five years comes to about $1.5 billion, a third of which stems from hidden fees.

Tommy Elliott, a senior vice president at Old National Bank who serves as chairman of the KRS Board of Trustees, said he was not bothered by the higher-than-average investment costs.

“I don’t have any discomfort with any of the choices we have made based upon the investment cost,” he said in an interview.

Jim Carroll, co-founder of the Kentucky Government Retirees group on Facebook, commended KRS for disclosing more investment costs.

“As a general rule, given the cash crunch we have, transparency in investments is more critical in our fund than any other,” he said. “It needs to be a core value. We’re literally running out of money and need to account for every penny.”

Reporter James McNair can be reached at jmcnair@kycir.org or (502) 814.6543.

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