To most of the sane world, charging clients lots of money for doing nothing—providing no meaningful product or service—sounds like the very definition of fraud. But much of what happens every day on Wall Street is far from rational or fair. Money managers have devised perfectly legal ways of getting paid millions for doing nothing and investors—even the supposedly most sophisticated pensions—routinely consent to these outrageously abusive payment agreements.
Fees on Committed, Uninvested Capital
It is common practice for private equity and other alternative investment funds to seek to charge investment management fees on “committed capital.” In 2017, reportedly 91 percent of private equity managers demanded investors pay fees today on money investors had committed to invest over time, say, over the next 10 years.
In other words, after the investor makes a capital commitment to a fund, management fees are charged on the entire commitment amount, regardless of whether the capital is actually drawn or invested. Paying fees on committed, uninvested capital results in exponentially greater fees on assets under management on a percentage basis.
For example, imagine a pension contractually agrees (commits) to invest $100 million (capital) in a fund over the next ten years, but only actually deposits $10 million into the fund early on. If the fee is 2 percent annually on committed capital (including the uninvested amount of $90 million), the pension will be charged fees of 2 percent annually on $100 million or $2 million, not 2 percent of $10 million or $200,000—even though the manager is only actually handling (investing) $10 million of the pension’s assets initially. Note that in the example, 2 percent on “committed, uninvested capital” equates to an astronomical fee of 20 percent of the $10 million actually invested initially.
Fees on committed, uninvested capital amount to paying money for nothing—no service whatsoever is provided in exchange for the lavish fees. In my opinion, such fees add insult to injury since these types of investment funds already charge exponentially higher fees than traditional stock and bond managers.
A 2015 forensic investigation of the Rhode Island state pension I undertook on behalf of the thousands of workers belonging to the American Federation of State, County and Municipal Employees Council 31 revealed that the pension was paying a group of money managers $30 million a year in fees on money that had yet to be invested—fees to Wall Street for doing nothing.
Likewise, my 2016 investigation of the New York State Teamsters Pension on behalf of its 35,000 participants showed the near-collapse pension paid $4.5 million in fees to Wall Street on committed, uninvested assets annually for nothing.
My most recent forensic investigation of the $90 billion State Teachers Retirement System of Ohio on behalf of the Ohio Retired Teachers Association revealed that as of June 30, 2020, the pension had unfunded alternative investment capital commitments totaling $7,152,101,083.
Assuming STRS Ohio pays fees of 2 percent on total unfunded commitments, this amounts to an annual waste of approximately $143 million—enough to restore 2 percent of the 3 percent COLA benefit that was taken from participants in the pension in recent years. When a pension claims it cannot not afford to pay teachers the 3 percent COLA they had been promised for their years of hard work and gratuitously pays Wall Street an estimated 2 percent or $143 million for no work at all, that sure sounds like a wealth transfer to me. Teacher wealth transferred to politically-savvy Wall Street billionaires, that is.
It should come as no surprise that reportedly some of the largest, most sophisticated investors recently have begun to question this practice. What is remarkable is that the audacious scam of charging fees on committed uninvested capital has endured for so long at our nation’s struggling public pensions. In my opinion, Ohio teachers deserve far, far better.