Money Stuff

Calpers Fees and Culture Consultants

Also IEX, tax inversions, transfer taxes and bond market liquidity.

Calpers and fees.

The California Public Employees’ Retirement System went and figured out how much it has paid in performance fees for its private equity investments since 1990, and most of what you need to know about the controversy is captured in the headlines. Just not any one headline. Calpers's own is "CalPERS' Active Private Equity Funds Generated $24.2 Billion in Net Gains for the Fund; Releases Profit Shared with Investment Partners." Bloomberg's is "Calpers Reports It Paid $3.4 Billion to Private-Equity Firms"; DealBook's is similar. But surely both numbers matter? How can you know if Calpers overpaid or not if you don't know what it was paying for?

So ... are those fees too much, or too little, or just right? They come to about 12.3 percent of gross realized gains, which is a lot lower than the 20 percent in the stereotyped "2 and 20" private equity fees. "I’d have thought the number would be higher," says an Idaho public pension officer. And "private equity is Calpers’ top-performing asset, producing returns of 12% over the past decade" and 12.3 percent (net) over the past 20 years, versus 8.2 percent for public equity over those 20 years. It probably should have higher returns, given its leverage and risk and illiquidity, so just the fact of the higher returns doesn't prove that it's worth the fees. But if you think that outperforming public markets by about 4 percentage points, net of fees and over a long period, is a good risk-return tradeoff, then the fees don't matter. If a private equity fund made 100 percent gross returns, charged 85 percent of those returns in fees, and gave Calpers only 15 percent net returns, that would be a great deal. More generally, if you think that Calpers shouldn't invest in private equity because the fees are too high, then you would effectively take away billions of dollars from California retirees in order to take away billions of dollars from "Wall Street." I'm not sure why that tradeoff would be worth it.

The Wall Street Journal's headline, meanwhile, is "Calpers’ Hidden Private-Equity Fees: $3.4 Billion," apparently because Calpers has never bothered to calculate its private-equity performance fees before. I am always a bit puzzled by the purported hiddenness of these fees. Like, you sign a contract saying that you'll get 80 percent of the gains and the fund manager will get 20 percent of them. The manager sends you a check for $80. How much did the manager keep? This is not a particularly hard problem, in the general case, though I suppose that private equity managers do have some history of obscuring fees.

Point72 and culture.

Oh man:

Doshi and McGregor, who fell in love while working at McKinsey, run a management consulting firm called Vega Factor whose motto is “We engineer high performing cultures.” They chose the name, according to the company website, “because our planet wobbles like a top, eventually, there will be a new North Star: Vega. By naming ourselves Vega Factor, we remind ourselves that nothing is constant.”

Super. I went to a former McKinsey consultant's wedding once; there was a Powerpoint presentation. Anyway, these particular husband-and-wife consultants are advising Steve Cohen's Point72 Asset Management on how to be nicer, and there is a lot of low-hanging fruit:

Former SAC employees are full of stories about Cohen’s acerbic manner. If a portfolio manager or analyst couldn’t answer a question about a stock, the billionaire founder was likely to lash out. “Do you even know how to do this f------ job?” was a standard barb. Impatience reigned. Cohen once upbraided a subordinate for having no trading ideas that year. It was the first week of January. The billionaire himself acknowledged his temper, once saying that employees need only worry if he yells at them after the market is closed.

The consultants are improving the culture by, among other things, revamping performance reviews and making people do math puzzles at Gabriele's Italian Steakhouse in Greenwich. 

IEX and the exchanges.

IEX, the Investors' Exchange, filed another comment letter in connection with its application to the Securities and Exchange Commission to become a lit stock exchange, and it is pretty feisty. The letter responds to objections by the New York Stock Exchange and Nasdaq to IEX's application, and it is as much an assault on NYSE, Nasdaq, and the perceived conflicts of interest in modern market structure as it is a defense of IEX. So for instance in responding to criticism of IEX's 350-microsecond "speed bump," IEX notes that "IEX round-trip latency," even after the speed bump, "is on average less than the round-trip latency of NYSE," suggesting that NYSE's unintended delays are longer than IEX's intentional delays. And:

We note that Nasdaq offers a variety of “connectivity types” to its co-located customers who have already paid for the privilege of co-locating. Nasdaq offers 1G, 1G Ultra, 10G, 10G Ultra, and 40G cross-connects, with prices ranging from $30,000 to $240,000 per year.  In order to induce members to pay for even faster access, each incremental step up (from 1G to 40G) results in a “latency improvement” between 5 and 24 microseconds. Of particular note, the total latency improvement for a member who purchases the highest tier of Nasdaq latency products is several hundred microseconds when compared with a baseline configuration. In other words, the “delay coil” that Nasdaq offers creates an equal playing field only for co-located customers that are also willing to buy the fastest cross-connect and other top-tier latency services that Nasdaq offers. 

As for NYSE's argument that it is unfair that IEX's pegged orders can reprice without going through the speed bump, IEX more or less changes the subject to NYSE's use of slower SIP feeds instead of direct pricing feeds:

Most important to the hypothetical scenario that NYSE poses is that actual “mispricing” of pegged hidden orders already occurs on NYSE as a result of the fact that, in contrast to many other exchanges and IEX, NYSE relies on SIP data to update its own view of current market prices and re-price its pegged orders. In the current market structure, because of significant differences between the speeds with which SIP and proprietary data are aggregated and sent to market participants, a market that relies on SIP data to update its view of current prices exposes any orders entrusted to it to inferior execution. By operating in this way, NYSE enables market participants that purchase its high priced high-speed proprietary data and access products to systematically disadvantage pegged and other orders resting on its order book. 

I don't know. IEX's speed bump, and the associated concerns about its router and pegged orders, are genuinely controversial. IEX says that the "insinuation that IEX is proposing a relatively more complicated market as a factual matter is categorically wrong," but I am not so sure. IEX is much simpler than other exchanges in many ways -- order types, connectivity options, etc. -- but it does add at least one element (the speed bump) that other exchanges don't have, and that seems to offer it some competitive advantages. On its own, it's perhaps fair to call IEX simpler. But if the SEC approves IEX's speed bump, then it won't have much excuse to prevent other exchanges from creating speed bumps, and they probably will if doing so offers advantages to them. And so the ecosystem as a whole will get a bit more complicated.

Elsewhere in market structure, "High-Speed Trading Would Face U.S. Scrutiny in New CFTC Plan," and here is the Commodity Futures Trading Commission's announcement of its new proposed Regulation AT, "a series of risk controls, transparency measures, and other safeguards to enhance the U.S. regulatory regime for automated trading."

Skadden and taxes.

The law firm of Skadden, Arps, Slate, Meagher & Flom LLP seems to be at the center of all of the recent big controversial tax deals, advising Pfizer on its not-quite-inversion merger with Allergan and Yahoo on its spinoff of its Alibaba shares, among others. This is a good place to be, for a tax practice, though also a risky one:

“It does seem like they are involved in all of the really difficult and controversial deals,” said Robert Willens, an independent tax analyst. “They have a great reputation in the tax area, but if they are found to be wrong on one or two, they go from looking aggressive and smart,” he cautioned, “to just looking aggressive.”

Elsewhere, Victor Fleischer argues that "history may remember" the Pfizer/Allergan deal "for finally killing off the United States’ outdated approach to taxing multinational corporations." And: "Senate Panel to Take On Inversions in Review of Global Taxation." And the Pfizergan breakup fees get as high as $3.5 billion.

Vanguard and taxes.

Does everyone know about the Vanguard tax controversy? It is maybe the wildest financial story I know; it is the faked moon landing of financial news stories, except that it might be true. The Vanguard Group is a mutual fund company whose adviser is owned by the funds, rather than being an independent profit-seeking corporation, so it can charge its funds lower advisory fees than its competitors do. (Disclosure: I am a Vanguard investor.) But the adviser is a taxable corporation, while the funds themselves are not taxable (they just pass through taxes to investors). There is a theory that the adviser should be charging Vanguard higher management fees, to reflect the "arm's length" prices that an independent adviser would charge, rather than the "at-cost" prices that it does in fact charge. Or rather, there is a theory that Vanguard owes taxes on the fees that the adviser should have charged, which would have been profit to the taxable corporation. Crazily, this theory is advocated by a former Vanguard tax lawyer in a purported whistleblower lawsuit seeking billions of dollars in back taxes, of which he wants a cut. Also crazily, there is no obvious flaw in this theory. Like, it seems right? But no one can quite believe it. Anyway here are a blog post and article called "Too Big to Tax? Vanguard and the Arm’s Length Standard," arguing "that the Vanguard 'at cost' pricing is unsustainable under the arm’s length standard, and that the IRS will win in court if it challenges Vanguard’s transfer pricing." It concedes that the IRS and New York attorney general have not gotten involved in the whistleblower case, presumably because no one actually wants to go after Vanguard for undercharging index-fund investors.

People are worried about unicorns.

" has closed $350 million in new funding, and says it has verbal agreements for another $150 million"; it raised this round seeking a pre-money valuation of $1 billion. " has now raised $570 million, which will balloon to $720 million once it closes on the additional funding." I feel like the way unicorns work is that if you've raised $X, and you have a valuation of $Y, and Y is way way bigger than X, then there's a good chance that at least some people are getting very rich. But the closer X gets to Y, the more everyone should worry. Elsewhere, "People around the world are using Airbnb to find their next hook-up." 

People are worried about bond market liquidity and swap spreads.

Here's a story about calls for central clearing of repo. "The use of repo helps maintain orderly trading in the world’s largest government bond market, but the imposition of expensive capital requirements on banks has made the business more costly," and investors "are asking what is available to replace some of the lost intermediation capacity." I will count that for bond market liquidity. Meanwhile in swap spreads:

Traders say current dislocations between the bond and interest rate derivatives markets reflect the important financing role played by repo, which has shrunk in size by a quarter since the end of 2008.

Elsewhere in bond market liquidity, a lot of closed-end credit funds are trading at a discount, attracting interest from the likes of Boaz Weinstein and Jeffrey Gundlach.

Me yesterday.

I wrote about Bill Ackman's recent Valeant options trades. I also wrote about "political intelligence" and insider trading.

Things happen.

BTG Pactual CEO Esteves Arrested In Brazil's Graft Probe, Police Say. Consumer Watchdog Pushed Discrimination Case on Vulnerable Firm: Report. Jacob Lew at Bloomberg View on "The Risk in Rolling Back Wall Street Reform." EMC and VMware Shareholders Demand Changes to Dell Buyout Deal. E.U. Proposes a Common Deposit Insurance Program for Eurozone. EU Needs 1-Year Delay to MiFID Market Rules, Commission Says. Deutsche Bank's Swiss Unit to Pay $31 Million in Tax Case. Luxembourg Goes in for an Image Makeover. Dream of New Kind of Credit Union Is Extinguished by Bureaucracy. Investment banks struggle to recruit working class students, humanities students, women, and white people. "I realised a long time ago that the only way to be passably good as a columnist is to be fairly sure that deep down you’re feeble." Penny review. Meat tax. Faerie Magazine. Newborn baby found in nativity scene at New York City church.

Money Stuff will be off tomorrow and Friday; have a good Thanksgiving! If you'd like to get Money Stuff in handy e-mail form, right in your inbox, please subscribe at this link. Thanks! 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Matt Levine at

    To contact the editor responsible for this story:
    Zara Kessler at

    Before it's here, it's on the Bloomberg Terminal.