Oxford SWF Project

Ashby Monk

There is an increasingly common trend among government-sponsored funds to take a greater role in (and responsibility for) asset management. We’ve seen this in Alaska. We’ve seen this in China. We’ve even seen this in Libya. And it seems to me that this trend is caused at least in part by a growing impatience with the fees charged by external asset managers, which has led certain funds to develop internal asset management capabilities to realize “alpha” for themselves.

But the latest fund to go this route is not a high-flying SWF. It’s a public pension fund from the state of South Carolina. Peter Lattman of the NYT is all over this story:

“…frustrated by what it sees as expensive fees and lack of transparency at private equity firms, one state has decided on a do-it-yourself approach. South Carolina’s pension fund is creating an independent firm to oversee the fund’s private equity holdings — doing what it would have paid a private equity firm to do. The effort is similar to the direct investment funds created by two of Canada’s biggest pension plans — Ontario Teachers’ Pension Plan and the Canada Pension Plan Investment Board — but is believed to the first of its kind in the United States.”

The rationale here is obviously to lower the costs associated with what is quite an expensive asset class. Indeed fees can be astronomical in the private equity industry. And I know this all too well: when I tell people I used to work at a successful PE shop in New York but left to pursue a career in academia, I get suspicious and curious looks that imply I must have been deranged to walk away from this kind of payday. Fair enough. But (!) these astronomical fees (while good for the PE insiders) often erode returns for clients. In fact, Booz & Company reportedly did an internal study that found that the SC pension could save $2 billion in fees and other costs over the coming decade by reducing its reliance on outside managers and investing directly. That’s huge. Now, that’s only one side of the equation (the other side is the returns generated for the fees paid), but it’s still a pretty compelling piece of data.

Even so, while funds might be intrigued by this strategy, it’s no panacea. In fact, it just creates a new set of problems for institutional investors. For example, if you are taking responsibility for the investment decisions, you better have the design, governance and competency to make this a successful endeavor. In other words, you need to operate according to best-practice standards of investment management. And this can be very hard in the context of a public fund, where it can be difficult to pay private sector salaries. Here’s the NYTs again:

“Although its reduced fees will save South Carolina money, the firm’s lower revenue will make it difficult to pay compensation on par with Wall Street firms.”

But if the fund can’t hire the talent, then this decision will inevitably fall into the “penny wise, pound foolish” category. That being said, when you see that a Russian monkey outperformed 94% of professional asset managers in 2009, you gotta feel pretty good about their chances. Good luck, South Carolina!