This story was co-published with the national investigative news outlet Capital & Main.
When Karen Magnuson appeared before a Colorado Senate panel in March, the 62-year-old retired teacher made a desperate plea: Avoid cutting the state pension system’s cost-of-living increase, or she and thousands of her fellow retirees throughout Colorado could be thrown into destitution.
“The costs of the things we need to live [on] keep going up and up,” said Magnuson, recounting how she is now working at a Target to make ends meet after a 32-year career teaching in Greeley, Littleton, Ault and Aurora public schools. “My calculations are telling me I'd better start preparing for poverty at seventy. It seems that many elected officials are trying to fix PERA on the backs of retirees with little to no chance to make up for these losses,” she added, referring to the state’s Public Employees Retirement Association.
Lawmakers ignored her request. They instead voted to advance legislation that would reduce Magnuson’s benefits in order to shore up the state’s finances — a move that recently prompted a statewide teachers' walkout and boisterous protests in a state where teachers' pay is below the national average.
As the Colorado Legislature now considers the final version of the PERA reform bill in the waning days of the 2018 legislative session, the consensus among lawmakers seems to be that Colorado must ask for more sacrifices from PERA's more than 500,000 members, who on average receive $3,000 a month in benefits and do not receive Social Security. And yet, despite all the talk of belt-tightening for state employees and retirees, lawmakers have not done anything to impede the nine-figure payments to one elite set of PERA beneficiaries: the wealthiest people on Earth, who live 1,600 miles to the east.
Ask legislators at the Colorado State Capitol if they’ve even heard about the $1 billion of investment fees that the state’s pension system paid out to external money managers between 2009 and 2016, and you will get blank stares. Ask them if they realize those are only the fees that are disclosed — and that there are likely hundreds of millions of dollars of additional fees being paid — and they will express disbelief. Ask them if they know that state officials passed legislation — written by the financial industry — barring the details of the fee terms from being revealed to the public, and you will elicit outrage.
This is a little-discussed reality at PERA — just as it is at many retirement systems across the country. And lately PERA has moved to funnel even more money into an opaque fund that is a mishmash of exotic investments from timberland to hedge funds — and has generated ever-higher fees while trailing the broader stock market.
In all, about a quarter of the $3 trillion of public retirement systems’ assets are now in “alternatives.” As of 2014, the shift into alternatives was generating $10 billion a year in fees — a 30 percent jump over the prior decade, according to the Pew Charitable Trusts. In response, some states have lately considered bills to expand fee disclosure — and California recently passed legislation that ended up revealing that the state is paying nearly $1.5 billion each year for its private equity investments.
However, many of the highest-profile transparency efforts have followed the script of Colorado Treasurer Walker Stapleton. The second-term Republican has made headlines demanding that PERA publish details of individual pensioners’ retirement benefits, but has mounted no similar effort to force the release of detailed information about the hundreds of millions of dollars Colorado pays the politically powerful financial industry. That’s the same industry that has pumped more than half a billion dollars' worth of campaign contributions into state politics across the country, and whose asset managers are routinely among the top donors to the Republican Governors Association that Stapleton will be relying on if he becomes the GOP nominee for governor.
The result: In nearly every state with revenue shortfalls, the political debate over pension reform primarily revolves around proposals to cut workers' benefits — while every-larger payouts to financial firms are considered sacrosanct and kept hidden from view.
The dynamic can be seen in Colorado: Few questions have been raised about why, for instance, the state’s pension fees helped Trump adviser Steve Schwarzman, the CEO of PERA money manager Blackstone, reap a personal $800 million windfall last year, all while lawmakers demand cuts to cost-of-living increases for retired teachers, firefighters, cops and other government workers.
Instead, financial firms and their trade associations have cast themselves as part of the solution, arguing that their alternative investments have produced returns that appear to eclipse the stock market — and are therefore worth the cost and secrecy.
“The long-term outperformance of private equity funds provides an excellent investment opportunity for pension funds representing teachers, firefighters and other public servants seeking retirement security,” says American Investment Council CEO Mike Sommers, whose group lobbies for the private equity industry in Washington, D.C. “Despite the recent strength of the stock market, investors in private equity generally received greater returns from these investments than public equities over the last ten years.”
“Despite the recent strength of the stock market, investors in private equity generally received greater returns from these investments than public equities over the last ten years.”
This argument is echoed by PERA’s chief investment officer, Amy McGarrity, who asserts that the investment strategy has made sure PERA has not fallen short of its target returns. “We have consistently met our assumed rate of return,” she says during an interview at PERA’s office building a few blocks from the State Capitol. Investing in alternatives has been part of a strategy to diversify the portfolio so that it does not just rely on stocks, she notes.
“That does require that we pay these kinds of fees,” she says, adding that while the state paying out more than $1 billion in fees over the past few years “sounds like a gigantic number, the honest truth is, the way we're able to generate this kind of return, which is far and above what you're going to get in your 401(k), is because this is the price of doing business.”
Industry critics, though, say those comparisons are not as straightforward as they may seem, because the returns on longer-term investments in real estate and private equity are based on somewhat subjective calculations by the money managers themselves, rather than a daily fluctuating stock price. They also note that many institutional investors betting big on high-fee alternatives have produced overall returns that trail low-fee stock index funds. In PERA’s case, the private equity and real estate returns have not matched the benchmarks that the system itself says should be used to measure the investments.
Such complexity — and fees — have led gurus like Warren Buffett and George Soros to warn pension funds to stay away from the investments.
“Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades,” Buffett wrote in his 2015 letter to Berkshire Hathaway shareholders. “A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game. There are a few investment managers, of course, who are very good — though in the short run, it’s difficult to determine whether a great record is due to luck or talent. Most advisors, however, are far better at generating high fees than they are at generating high returns.”
one-fifth of retirees’ savings — or $9 billion — into private equity, real estate, hedge funds and a blend of other alternatives. The result: The state’s returns have been subpar by many measures.
PERA’s 2016 report shows that in the previous decade, the retirement system delivered an annualized 5.2 percent rate of return — below the 5.5 percent annualized returns for the median public pension system, according to data compiled by the Wilshire Trust Universe Comparison Service. By comparison, Vanguard’s low-fee Balanced Index Fund — comprising 60 percent stocks and 40 percent bonds — generated 6.4 percent annualized returns in the same time period.
Those differences in return rates may seem small, but when applied to tens of billions of dollars over the course of a decade, the underperformance translates into hundreds of millions of dollars that PERA failed to reap.
In a shorter time horizon, the picture is a bit brighter: In its 2016 annual report, PERA reported an 8.5 percent return over the most recent five years — but even that has trailed a traditional Vanguard fund, and it also trailed at least one of its peers in the Intermountain West. Nevada’s public pension system, which is 12 percent smaller than PERA and has far less exposure to private equity and real estate, earned a 9.1 percent return during the same five-year period. That outperformance came at a cheaper cost: Nevada paid 75 percent less in fees than did Colorado, paying half a billion dollars less to Wall Street than PERA did.
To be sure, Colorado could simply follow the lead of Nevada or even Montgomery County, Pennsylvania, which famously shifted its assets into index funds — but solely moving money into lower-fee investments, even if they performed well, would not solve the pension system’s challenges (nor would transforming the system into a 401(k)-style system, that data suggest could generate even higher fees).
“You can argue that Colorado should have used index funds instead of wasting money on Wall Street fees."
Right now, Colorado faces a $32 billion gap between the assets it has and the benefits it promises. A 2015 report from the Laura and John Arnold Foundation — which critics say has pressed for pension benefit cuts — found that much of the shortfall was created by the state government and local school districts for failing to make their full employer-side contributions to the fund for years.
That same report, though, also noted that more than 17 percent of the gap was created by shortfalls in investment returns, as the state has continued to pay an average of $132 million in annual disclosed fees to external money managers this decade.
“You can argue that Colorado should have used index funds instead of wasting money on Wall Street fees,” says Johns Hopkins University professor Jeffrey Hooke, a former investment banker whose recent report shows that many pension systems heavily invested in alternatives have underperformed traditional stock and bond index funds. “The problem is that Colorado, like most state pension funds, hasn’t been able to beat the kind of simple index fund of 60 percent stocks and 40 percent bonds that a place like Vanguard has.”
Colorado began pumping state retirement money into private equity in the 1980s, before it was called private equity. Back in those pre-euphemism days, it was just called “leveraged buyouts,” and its promises of huge shareholder returns — regardless of social consequences — were popularized by Gordon Gekko in the film Wall Street.
In its simplest form, private equity executives raise money from investors like pension funds, which agree to give those executives retirees’ savings for about a decade. The private equity firms then use those resources and bank loans to buy up companies. In the Mitt Romney campaign-ad version of the tale, the private equity executives then earnestly try to turn a profit for investors by retooling the companies, making them more efficient and selling them off at a higher price. In the Occupy Wall Street version of the story — which seems to be at play in the demise of the Denver Post — the Mitt Romneys strip the companies of assets, lay off workers and make quick cash in a fire sale.
For pension funds, the move into private equity, hedge funds, real estate and other more exotic investments has always been about their potential to generate big returns that are not tied to the stock market — a situation that, in theory, insulates pensioners from the day-to-day ebb and flow of the S&P 500.
“This shift reflects a search for greater yields than expected from traditional stocks and bonds, an effort to hedge other investment risks, and a desire to diversify the investment portfolio,” writes Alicia Munnell of Boston College’s Center for Retirement Research.
Since Governor Roy Romer’s last term, Colorado has poured billions into 257 separate private equity funds, according to government records. During that time, PERA, along with the Denver Public Schools Retirement System that it merged with in 2010, pumped cash into funds run by such Wall Street giants as Goldman Sachs, Warburg Pincus and Blackstone. Pension officials also dumped money into obscure vehicles with names that sound like the codes Enron executives used for their shell companies — stuff like Euroknights V, JC Flowers Fund II and PMI Mezzanine Fund.
“This shift reflects a search for greater yields than expected from traditional stocks and bonds, an effort to hedge other investment risks."
In all, between 1998 and 2016, the $10.6 billion of Colorado’s private equity investments have returned $10.8 billion to the pension fund — hardly the outsized returns that industry officials tout.
Real estate is a similar story. State records obtained by Capital & Main show that PERA’s portfolio includes 100 percent direct-ownership stakes in far-flung properties across America — from shopping centers in Birmingham, Alabama, and Tampa, Florida, to an office park in Walnut Creek, California, to a Disney distribution center in Memphis.
For PERA’s $4 billion worth of real estate investments, it has received a 5.6 percent annualized return over the last decade. In that same time, Vanguard’s 60-40 stock-bond fund delivered a 6.4 percent return.
That said, when it comes to PERA’s overall returns in alternative investments, the jury is still out because a sizable chunk of Colorado’s current $3.5 billion private equity portfolio remains locked up in ongoing private equity funds. In other words, depending on how well those investments perform, PERA is set to receive more payouts. State officials, in fact, assert that over the last decade, private equity has delivered PERA an annualized 8.4 percent return and that over the portfolio’s entire life, there has been a 10.4 percent “internal rate of return.”
That calculation, though, is not based on any third-party verification, but is instead based on figures from the investment firms themselves — a situation that PERA officials admit makes the figures difficult to rely on.
“Differences in IRR calculations can be affected by cash-flow timing, the accounting treatment of carried interest, partnership management fees, advisory fees, organization fees, other partnership expenses, sale of distributed stock, and valuations,” state records disclose in fine print. “Importantly, there is no industry-standardized method for valuation or reporting.”
Financial experts have long expressed concerns about the fungibility of these calculations, raising questions about whether or not the purported value and returns of PERA and other pension funds' portfolios is the actual value of the assets. Both New Jersey’s public pension fund and a recent academic study underscored those concerns.
In the New Jersey case, the state’s early sale of investments in real estate funds in 2012 showed a wide discrepancy between what Wall Street firms were saying the state’s investments were worth and what they actually sold for on the open market. A few years later, a study published by the National Bureau of Economic Research found “evidence that some underperforming managers boost reported returns” when they are trying to sell prospective investors on putting money into their new funds.
“Until a private equity fund or real estate fund is fully liquidated, pension officials don’t really know what these investments are worth. They are taking the fund managers’ word for it,” says Johns Hopkins’ Jeffrey Hooke. “The returns could just be made up.”
“Until a private equity fund or real estate fund is fully liquidated, pension officials don’t really know what these investments are worth."
Questions about the veracity of stated returns have only intensified in recent months, as federal regulators have been looking into whether private equity firms massage, tweak or otherwise manipulate those calculations to obscure less-than-stellar performance. One of PERA’s largest external managers, Apollo Global Management, was reportedly subpoenaed in that investigation.
What is not fungible is PERA’s own data: Buried in the retirement system’s 2016 annual report are figures showing that in the prior ten years, Colorado’s private equity and real estate portfolio fell short of standard industry benchmarks that compare returns to other, lower-fee investments. The report also showed that the system’s $1.5 billion “Opportunity Fund” has delivered just 2.8 percent in annualized returns in the prior five years — compared to more than 10 percent in annualized returns for the stock portfolio that PERA manages in-house. In 2015, PERA increased the amount of money it aims to put into the Opportunity Fund.
McGarrity says that when it comes to the Opportunity Fund, “a lot of those investments in there have the J curve” — an industry term describing when returns are weak at the beginning but then increase as investments generate a profit. As for the other alternative investments, she says they've delivered.
“The overall goal of private equity is to outperform [the stock market] over the long term, and our performance has proved that,” she tells Capital & Main, asserting that the high-fee investments have generated better returns than the system’s investments in stocks and bonds. “That's its role in the portfolio, and we believe it's been successful in fulfilling that role.”
However, there are signs that the much-ballyhooed returns of the past may not be a thing of the future.
In October, a Cambridge Associates’ report showed that its private equity index trailed the S&P 500 returns over the prior five years. That followed Blackstone’s head of private equity declaring, “This is the most difficult period we’ve ever experienced.”
Eileen Appelbaum and Rosemary Batt of the left-leaning Center for Economic and Policy Research say the trends are ominous for investors like PERA.
“Industry participants claim that these funds significantly outperform the stock market, but finance economists who study the industry have found considerably more modest results,” they wrote in a 2017 report. “The overall performance of private equity funds has been declining. While private equity buyout funds once beat the S&P 500, the median buyout fund has more or less matched the performance of the stock market since 2006. These findings raise serious questions about whether the recent investment explosion in [private equity] will pay off for pension funds and other institutional investors.”
Like statistics, performance returns are notoriously squishy; depending on timetables, weighting and other tricks, a math whiz can paint different portraits. The same is true for the fees being paid to financial firms managing retirees’ money, but for a different reason: The expenditures can’t exactly be massaged with fancy formulas, but they can be — and are — hidden from view.
Indeed, even as PERA officials have been providing lawmakers with meticulous actuarial estimates of the costs of retiree benefits, those same officials may not actually know precisely how much Colorado is shelling out to Wall Street firms — and even if they did know, they are not allowed to tell you.
Between 2009 and 2016, PERA disclosed spending roughly $1.2 billion to manage all of its investments. More than two-thirds of those expenses were fees paid to firms managing money in the private equity, hedge fund and Opportunity Fund portfolios, even though those managers only oversaw roughly 20 percent of the state’s overall investments.
On paper, PERA seems to be paying about 0.4 percent in fees on the system’s $47 billion in assets — not among the highest fee rates for pension funds, but also not among the lowest, according to a 2015 study published by the Maryland Public Policy Institute.
is, those are only the fees that are disclosed to the public — and there are many more that go unreported.
“If you aren’t looking over their shoulder, you'd better make sure their hands aren’t in your pocket."
PERA, for instance, publishes a list of private equity firms it does business with — but it does not publish a list of managers in its real estate portfolio or the Opportunity Fund. (You have to make a formal request for those records.) Similarly, PERA publishes the aggregate annual cost of the flat management fees charged by its external firms — usually around 2 percent of an investment. The retirement system, though, does not disclose the so-called “carried interest” fees that financial managers extract from the system’s investments when those investments increase in value. That fee is typically 20 percent of the earnings, which, according to Hooke, means the system in practice is likely paying nearly double the amount of fees it admits to in its annual reports.
There also could be hidden fees that Colorado officials are not privy to — the kind that were flagged by law enforcement officials in a series of recent cases brought against a pair of private equity firms in which PERA has collectively invested more than $1.7 billion since the 1990s. In the Securities and Exchange Commission’s actions against those two firms, Apollo and Blackstone, the regulatory agency said the managers failed to disclose fees they were charging to the underlying companies they were buying with investors’ money.
Those fees charged to investors’ assets are not necessarily shared with the investors themselves; they can be akin to your financial planner using your investment money to buy bars of gold and then quietly breaking off pieces of the bars for himself. And if you think those are isolated incidents, think again: In 2014, the director of the SEC’s Office of Compliance said, “When we have examined how fees and expenses are handled by advisers to private equity funds, we have identified what we believe are violations of law or material weaknesses in controls over 50 percent of the time.”
PERA board member Lynn Turner says that when it comes to the debate over investment expenses, “the issue is what you get in return for what you pay. If you pay higher fees but get higher returns for those fees than you could from other investments, then it is worth paying those fees.” He adds, though, that in light of the SEC’s recent fee cases, one of PERA’s toughest jobs is to police its own money managers.
“If you aren’t looking over their shoulder, you'd better make sure their hands aren’t in your pocket,” says Turner, who notes that as the SEC’s chief accountant, he saw private equity firms use fee schemes to siphon money from investors. “When we see these people getting in trouble for what they are doing, any pension fund should ask if we should be doing business with these people. We shouldn’t turn a blind eye. I would like to see a lot more transparency and a lot more proactive due diligence about whether we should remain in business with them.”
With so much public money at stake — and with periodic shenanigans surrounding all that cash — legislators, state auditors, journalists, watchdog groups and PERA members themselves may at some point want to dig more deeply into the situation. But if that time ever comes, they will run into a wall of secrecy, thanks to a bill quietly passed in 2004 by unanimous votes in the Republican-controlled Colorado Legislature.
The legislation was originally “developed by the venture capital industry,” according to PERA records — and it mimicked similar bills that the financial industry was then passing in most states as public pensions at the time were investing ever more money in higher-risk, higher-fee alternative investments. Colorado’s two-paragraph legislation gave PERA the right to hide all information about private equity, debt and timber investments if pension trustees determined that “disclosure of such information would jeopardize the value of the investment.”
PERA’s alternative investment portfolio was then a fraction of the size of its current portfolio. Representatives of a private equity industry lobbying group called the Pension Preservation Alliance told lawmakers that financial firms were weaponizing open-records laws — using them to get pension funds to disclose commercial trade secrets about their competitors’ investment strategies.
“Here’s the problem: PERA cannot decide to make an investment in a company until it receives and reviews enough proprietary information in that company to satisfy its investment concerns, but the company won’t share that level of information if it is at risk of public disclosure,” then-Pension Preservation Alliance executive director John Frew told senators in testimony supporting the legislation. Without an exemption, Frew asserted, “some alternative investment partners may choose to avoid public investments altogether.”
Lobbyists for the private equity industry reassured lawmakers that PERA could be judicious in its use of the exemptions and still disclose plenty of information about its Wall Street relationships. But a few months after Republican Governor Bill Owens signed the final bill, PERA’s board unanimously approved a sweeping motion exempting all of its contracts with alternative investment firms — and all itemized fee information — from the state’s open-records laws.
“The Colorado Open Records Act protects investment firms worried about the disclosure of trade secrets and confidential commercial and financial data — that sort of information typically is redacted from government contracts before they are made public,” says Jeff Roberts, executive director of the Colorado Freedom of Information Coalition, which advocates for more transparency. “So it's difficult to understand why another provision in the law gives the pension fund so much discretion to withhold just about any information about alternative investments. When the records are closed, how can pension participants and taxpayers evaluate the investments? How can they tell if the fees are excessive?”
When the SEC sounded an alarm about private equity fees in 2014, a prominent law firm began encouraging its Wall Street clients to pressure public officials nationwide to invoke these exemptions to prevent information from flowing to media organizations.
“We have recently observed a surge in freedom-of-information requests made by media outlets to state pension funds."
“We have recently observed a surge in freedom-of-information requests made by media outlets to state pension funds,” said a bulletin from Ropes & Gray. “The requests tend to focus on information about advisers’ treatment of fees and expenses. ... Record-keepers at state investment entities may reflexively assume that all information requested should be disclosed. But a prompt response, supported by the applicable state law, can help ensure that confidential information that is exempt from FOIA disclosure is in fact not released.”
Why do firms and pension systems want to keep these documents secret? There are clues in documents republished by the website Naked Capitalism after Pennsylvania officials inadvertently posted them on the state government’s website.
A Blackstone contract, for instance, gives that private equity behemoth authority to charge fees to firms it has bought with investors’ capital — precisely the authority that the SEC regulators said that Blackstone abused in its 2015 case against the company.
A separate Apollo contract gives that firm the right to charge management fees on pensioners’ money, even if Apollo hasn’t yet invested the cash in the market; Apollo can also use investors’ money to fly its executives around on chartered jets. The Apollo document admits that when it reports asset values to its investors, those valuations may differ from “the values that would have been established by any person” and may differ from “the actual prices” that the assets may fetch on the open market.
PERA has collectively committed more than $230 million of retirees' savings to those same Blackstone and Apollo funds whose rights are outlined in those contracts.
“There are two groups of people who want to keep all this info secret — the pension plans and the fund managers — because they know that if these documents become public, people can see the true risks and costs of these investments, and how they they are not nearly as lucrative as the industry would have you believe,” says South Carolina State Treasurer Curtis Loftis, a Republican who has for years demanded more transparency from his state’s pension fund. “Put it this way: If the average businessperson read one of these private equity contracts, they would never invest their own money in a private equity deal, because they’d be able to see that these agreements favor nobody but the private equity firms.”
McGarrity tells Capital & Main that under PERA’s interpretation of the confidentiality law passed in 2004, pension overseers refuse to disclose fee and investment terms to not only the public, but also to legislators overseeing the system. She says that PERA staff and trustees have access to the information they need, and the public entrusts those officials to do their jobs.
“Almost all public funds do exempt these types of investments from open-records acts, and it's really to enable us to participate with these partnerships and get to invest in these types of funds,” she said.
When asked why lawmakers are not allowed to even see fee details and investment terms that have nothing to do with a Wall Street firm’s commercial trade secrets, she said: “I don't really have...I'm not really prepared to answer that question.”
Gina Kirkpatrick, a 37-year-old Spanish-language arts teacher at Kepner Legacy Middle School in Denver, says that while she had never previously heard of the fees and the secrecy, she was not surprised, because “I feel like there’s corruption at every level.”
Jennifer Strand, a 56-year-old teacher from Mitchell High School in Colorado Springs, was even more direct, declaring: “PERA doesn’t want people who receive benefits to know all this. They don’t want us to know how they may be mismanaging our funds. My God, I’m going to retire in six years, and I’m petrified that I’m not going to have any retirement. And with all the proposed changes, they want us to cover their bad mistakes, they want us to pay for it.”
Lynn Turner, the former SEC auditor, concedes that he, too, is frustrated with the fees and secrecy — and said one solution may involve bringing the management of private equity and real estate investments in-house, much as the teachers’ pension system does in Ontario, Canada.
“If we or a group of public pensions can do our own thing and be more efficient and get the same returns, then there’s no sense in paying these firms tons of money,” he says. “My hope would be that over time we would figure out how to do that with other funds — and then they wouldn’t have to pay these fees, and the fees we do pay would be lower because the big firms would have to reduce their costs to be competitive. It’s something we should look into, because right now, we are basically transferring a lot of wealth from Americans who are putting up the money to those guys on Wall Street.”
McGarrity makes a broader argument, insisting that any question about transparency and fees is really “a question of our custodianship and the trust that [PERA members] engender in us every day. I think over time, we've generated the kind of investment performance that [is] keeping our members in retirement security.”
Today's PERA situation, he says, is more of the same.
“It doesn’t surprise me, because this is the game that’s now being played in finance,” adds Buck, who has been at Denver Public Schools nineteen years. “In the United States in general, money is flowing toward the top half a percent and away from everyone else. This is the same effect. Everything is sort of getting looted right now, and if you are aren’t doing better than 15 percent or so, which is what the S&P did, then you are not generating great returns. They can pat themselves on the back if they want, but I don’t see it.”
David Sirota is a Denver-based investigative journalist for Capital & Main; his wife is a candidate for the Colorado Legislature.
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