• California pension reported it shared $3.4 billion with firms
  • Texas, New York, California Teachers' also looking at fees

The biggest U.S. public pension system may have set off a race among funds to disclose the amount of profit they’ve shared with private-equity firms.

The California Public Employees’ Retirement System on Tuesday released a much-anticipated report saying its private-equity managers, such as Blackstone Group LP and Apollo Global Management LLC., reaped $3.4 billion since 1990 under profit-sharing agreements. Calpers earned $24 billion on those investments during that time.

Such profits have become a flash point in the debate over whether taxpayer-financed pension funds should take on the risks and complexity common in private-equity deals, and whether investors are getting their money’s worth. Increasingly, pensions have turned to alternative investments rather than traditional stocks and bonds to boost returns needed to match lifetime benefits promised to government workers.

“Calpers might unleash a trend here,” said Reena Aggarwal, a finance professor at Georgetown University in Washington. “Because Calpers is going through this exercise, it’s going to mean that other large institutional investors are going to be asking their private-equity firms the same questions.”

The pension fund, the seventh-largest investor in private equity, had been criticized for not tracking the money at a time when its costs are under scrutiny.

Tax Treatment

The way the carried interest profits are taxed -- at rates lower than what most American workers pay -- also has become an issue in the U.S. presidential campaign. President Barack Obama wants to tax carried interest as ordinary income at rates up to 43.4 percent, instead of as capital gains at 23.8 percent. Democrat Hillary Clinton and Republicans Donald Trump and Jeb Bush have said they would rein in the discount.

“This whole issue of the taxation of carried interest will not go away,” said Douglas Holtz-Eakin, president of the American Action Forum, a Washington-based conservative policy institute. “Right now, the presidentials are focused on foreign policy, but campaigns last a long time. I expect us to revisit this again and the Calpers data will be in the center of that.”

Private-equity managers typically charge investors a 1 percent to 2 percent annual management fee on committed capital that is taxed as income. They generally also keep 20 percent of investment profits as carried interest. In addition, firms sometimes waive some of the management fee in exchange for an equivalent amount from a transaction such as the sale of a company, lowering tax bills even more.

Over time, the Calpers disclosure “will raise questions about whether the total amount of compensation paid to private-equity managers is more than is necessary,” said Michael Flaherman, a former Calpers board member and visiting scholar researching public-pension investment at the University of California at Berkeley. “A reasonable conclusion would be it can’t possibly require them that much money to get them out of bed.”

Taking Notice

The Calpers data disclosure isn’t complete, because it was collected only from active investments, about 80 percent of those made since inception a quarter century ago, Ted Eliopoulos, the pension’s chief investment officer, said Tuesday in a conference call with reporters. A fifth are now inactive.

“Calpers has invested in many funds that are no longer active, no longer included in our portfolio,” he said. “We have limited recourse and access to the information for those funds that are no longer in the portfolio.”

Other retirement systems are taking notice.

New Jersey’s $79 billion public pension already reports carried interest, and disclosed that it paid about $600 million in private-equity fees and incentives in 2014 with $334.8 million going to carried interest. The California State Teachers’ Retirement System, the second-largest U.S. fund, will consider whether to collect similar information from its managers at a February board meeting, spokesman Ricardo Duran said.

The New York City Comptroller’s office last month asked private-equity managers to provide the base and performance fees they charge the New York City Employees’ Retirement System by Dec. 31. Chief Investment Officer Scott Evans said fund managers that refuse to comply could be dropped from future investments with portfolio.

In Texas, the Employees Retirement System is looking at whether it should collect such data, though its investments may be too young to provide meaningful information, Keith Yawn, a spokesman, said in an e-mail.

Pension-fund managers who rely on private equity say the fees are worth the profit in the end.

“The cause-and-effect relationship between performance fees and performance itself means that higher profit-sharing fees are symptomatic of higher performance – a net benefit to our stakeholders,” Gary Bruebaker, the chief investment officer of the Washington State Investment Board, said in an e-mailed statement.

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