The Pennsylvania Public School Employees’ Retirement System is seeking to reduce the real estate fees it pays by $900 million over the next 30 years – part of a larger effort to cut $2.5 billion in fees across asset classes over that period, the pension system said in a statement following its August meeting.
Within real estate, PSERS plans to reduce its externally-managed private real estate holdings from 9.8 percent of its overall portfolio – or $5.1 billion – to 7.8 percent ($4.07 billion). It estimated that cutting its overall private real estate portfolio by 20 percent will save $10.3 million per year in fees.
In decreasing its externally-managed property holdings, PSERS in turn seeks to increase its allocation to co-investments from 2.3 percent to 8 percent – or $122 million to $335 million – of its private real estate portfolio. Most of the pension’s real estate portfolio is invested in private funds, but co-investing has been a particularly successful strategy. PSERS, which began co-investing in real estate in 2012, has generated a 21.8 percent internal rate of return and a multiple of paid-in capital of 1.36x through this program, according to a document prepared by PSERS investment professionals. The pension highlighted lower fees in co-investments, which typically charge 50 percent of a fund’s base fee and profit sharing.
In order to broaden its access to co-investment dealflow, PSERS’ board may need to expand its policy parameters to allow co-investments alongside funds with which PSERS does not have a relationship. PSERS could also partner with pension funds with direct investment programs or other general partners, it said in board materials.
To manage an expanding co-investment program, PSERS would hire an investment professional because the system currently lacks the “human resources to effectively evaluate” all its opportunities. While that professional would increase costs by $350,000 annually, starting in the 2019 fiscal year, PSERS would save a net $750,000 each year.
By both lowering its allocation to private real estate funds and increasing the allocation to co-investment, PSERS estimates it will save $11 million annually. The pension system predicts it will take three years to reach full fee savings. If the savings are compounded at 6.6 percent, PSERS forecasts it will save $900 million over 30 years.
In December, the PSERS board instructed its investment staff to present a plan for reducing over three years the management fees paid to external managers. PSERS, which managed $61.5 billion overall and $6.2 billion in real estate as of June 30, 2017 – its benchmark for the study – worked with investment consultants Aon, Askia and Hamilton Lane on the proposal. At its August meeting, the PSERS board approved the portfolio-wide plan and authorized its investment staff to implement the recommendations.
Overall, PSERS predicts it can save $38.7 million in three years from fee reductions across asset classes and $2.49 billion over 30 years. However, if the system cannot get approvals for the nine investment professionals it wants to hire for in-house management, savings drop to $1.55 billion over 30 years, “with the bulk of the lost savings coming from not being able to manage more co-investments in private equity and private real estate,” the PSERS plan said.
Other pension systems have also embarked on long-term initiatives to reduce fee payments. The California Public Employees’ Retirement System, for example, is trying to cut its number of external real estate managers from 50 to 15 from 2015 to 2020, PERE previously reported. The country’s largest pension system reduced its external real estate management fees, including profit sharing, from $825 million in the 2013-2014 fiscal year to $186.5 million for the 2016-2017 fiscal year, according to its most recent annual review.