Federated
Annual Fee Report - 2021
1 Executive Summary
This report marks the seventh anniversary of our annual Fee Report for the Federated City Employees’ Retirement System (“Federated”, “Plan”). The goal of the report is to provide transparency and insight into the fees and expenses paid to investment managers along with the costs of operating the investment program. Pension plan fee data is generally underreported by peers, and typically represents only the portion of fees that are observable. This excludes often sizable embedded fees (such as incentive fees) that are deducted from account values of certain fund structures.
It is important to note that fees are a function of asset allocation and portfolio construction, which are byproducts of the Board’s objectives, investment beliefs, and risk tolerance. Each year, the Board typically reviews the asset allocation considering updated capital market assumptions and the expected returns and volatility of the portfolio associated with those assumptions. The asset allocations in effect for the period covered by this report, as illustrated in tables 1 and 2.
Asset allocation is typically one of the largest determinants of investment management fees at the portfolio level. Asset allocations that introduce alternative asset classes (Private Equity, Private Debt, Real Estate, Hedge Funds, etc.) will have higher levels of investment manager fees, because these asset classes or strategies have higher fee structures than traditional asset classes. In addition, asset class structuring can have a significant impact on fees. The use of active management versus passive management, as well as alternative strategies within traditional asset classes, will increase fees. When evaluating investment managers, staff places a significant emphasis on fees by negotiating for lower fees and analyzing that expected value or return is worth the expected cost.
For calendar year 2021, management and incentive fees for the pension plan totaled $44.6 million with a fee ratio of 1.55% as compared to $23.6 million and 0.95% for 2020 and $19.2 million and 0.89% for 2019. Fund operating expenses were $3.1 million in 2021 for a fee ratio of 0.11% as compared to $4.0 million and 0.16% in 2020 and $3.8 million and 0.18% for 2019. The health care trust management and incentive fees totaled $0.8 million with a fee ratio of 0.21% as compared to $0.6 million with a fee ratio of
0.21% in 2020 and $0.7 million with a fee ratio of 0.24% in 2019. Other investment-related costs (staff, consultants, custodian bank, investment legal, etc.) for the pension plan in 2021 were $2.0 million with a fee ratio of 0.07% as compared to $1.7 million and 0.07% in 2020 and $1.9 million and 0.09% in 2019. Other investment-related costs for the health care trust totaled $0.3 million with a fee ratio of 0.07% as compared to $0.2 million and 0.06% for 2020 and $0.2 million and 0.07% for 2019.
2 Table 1 - Pension Average Asset Allocation for 2021
Table 2 - Health Care Trust Average Asset Allocation for 2021
Global Equity
49%
Private Markets
22%EM Debt
3%
High Yield
2%
Immunized
Cash Flows
4%
Market Neutral
Strategies
2%
Cash
1%
Core
Real
Estate
4%
Commodities
0%
TIPS
2%
Long Term Govt
Bonds
2%
Investment
Grade Bonds
8%
Global Equity
59%
Short Term IG
Bonds
17%
Cash
1%
Core Real
Estate
9%
Commodities
5%
Investment
Grade Bonds
6%
Long Term
Government
2%
3 Introduction
The fees in this report represent management fees, incentive fees, fund operating expenses, and other investment-related costs that were incurred during the calendar year. These amounts may include fees that were accrued for the year, but not paid out.
Management fees are fees charged by fund managers to invest and manage assets. Incentive fees are performance-based fees for exceeding a hurdle return and are only applicable to certain fund structures. It is important to note that incentive fees are a form of shared economics that are only paid if the manager has produced positive returns or exceeded a predetermined hurdle rate. In some situations, incentive fees can be negative, reflecting the complexity of fee agreements. Operating expenses include overhead related to managing a fund that are indirectly borne by investors, which may include professional, administration, research, tax, legal, custodial and audit expenses for a fund. Trading expenses such as broker commissions are excluded from this report. Other costs include salary and benefits compensation for investment staff (including a 50% allocation for the CEO), cost of consultants (general, absolute return, risk), custodian, other third party vendors utilized by the investment program, and investment staff travel.
Though best efforts have been made to capture all material fees and expenses, this report may not include all indirect expenses and charges that may be paid to managers’ affiliates, consultants, or entities for services rendered to the managers, the funds or portfolio entities held by certain funds. Future iterations of this report will continue to grow in sophistication, benefiting from industry-wide initiatives to gain additional transparency, such as the increasing adoption of the Institutional Limited Partners Association (“ILPA”) fee reporting template.
Data Sources
Staff compiled this fee report using the best available information for each fund manager to develop a comprehensive view of fees.
Fee amounts were reviewed for reasonableness and reconciled to fee schedules. Fees for all managers active at any point during the year are included in this report, including those that were initially funded or terminated mid-year. 4 Fees for mutual funds, short term investment funds (Cash), and certain public markets commingled funds that deduct fees directly from the funds were calculated by multiplying each funds’ fee ratio by the funds’ average monthly balance for the year. The average balances were sourced from the Plan custodian bank, State Street.
Fees for Private funds were gathered by asking managers to complete the ILPA fee reporting template. The ILPA template is intended to standardize and codify the presentation of fees, expenses, and carried interest information by fund managers to Limited Partners. The remaining manager fees were obtained by having the fund managers fill out a fee template designed by staff.
Within the Other Costs section, consultants, custodian banks, and other vendor costs were sourced from fee invoices from the vendors. Investment staff salary and benefits were allocated to each of the four San Jose plans by pro-rating the total costs by the average balance of each plan. Similarly, legal costs incurred by Federated were allocated between the pension plan and health care trust by pro-rating the total costs by the average monthly balance of each plan.
Total Portfolio Fee Summaries
The tables in this report present fees by asset class and management type. Fees by management type are presented by segregating investments into four “fund type” categories: passive, active, hedged, and private. Passive strategies are intended to generate a return that emulates an index. Active strategies include investment managers that attempt to outperform an index on a long only basis. Hedged strategies generally seek to achieve an absolute return (“alpha”) regardless of market direction (“beta”) by employing various strategies including long and short positions. Private strategies utilize a diverse set of approaches to invest in illiquid assets, such as equity of privately held companies or real estate.
Year-over-Year Comparisons
The year-over-year comparison tables in this report present a time series of changes in average weights, fees, fee ratios, contribution to total plan fee ratios, and a year-over-year attribution. The year-over-year attribution uses the Brinson-Fachler methodology to decompose the change in contribution to total plan fee ratio into 1) impact due to weight changes, 2) impact due to management fee ratio changes, and 3) impact due to incentive fee ratio changes, and 4) impact due to fund operating expense ratio changes. 5 California Government Code §7514.7 (AB 2833)
Assembly Bill 2833 (“AB 2833”) was approved on September 14, 2016 adding Section 7514.7 to California Government Code. The addition to the Code requires California public investment funds to make annual disclosures of fees for alternative investment vehicles at a public meeting.
Tables 15-19 of this report are intended to comply with the law.
Note: Some values on the report may not sum due to rounding.
6 Table 3 - Pension Fees by Asset Class and Management Type
The table above illustrates that management, incentive, and operating expenses for the pension plan totaled $47.7 million for 2021 which equated to a total plan fee ratio of 1.66%. The Private Markets and Public Equity Strategies contributed the most to the total plan fee ratio at 1.22% and 0.17%, respectively.
7 Table 4 - Pension Fees by Management Type
For the total pension plan, Private management funds accounted for 1.22% of the total plan fee ratio and represented about 15.7% of average plan assets. Active management strategies were the next largest contributor to the total plan fee ratio accounting for 0.22% of the total plan fee ratio and represented 33.5% of average plan assets. Passive and hedged strategies accounted for 0.02% and 0.20% of the total plan fee ratio and represented 46.7% and 4.1% of plan assets, respectively.
Table 5 - Pension Other Investment Costs
Other investment costs for the pension plan equated to a total fee ratio of 0.07%. As previously discussed, other costs include salary and benefits compensation for investment staff, cost of consultants, custodian, third party vendors utilized by the investment program, and investment staff travel.
8 Table 6 - Health Care Fees by Asset Class and Management Type
The table above illustrates that management, incentive, and operating expenses for the health care trust totaled $0.9 million for 2021 which equated to a total plan fee ratio of 0.24%. The Global Equity asset class contributed the most to the total plan fee ratio at 0.15%.
Table 7 - Health Care Fees by Management Type
For the total health care trust, active management strategies accounted for 0.20% of the total plan fee ratio and represented 26.9% of average plan assets. Passive strategies accounted for 0.04% of the total plan fee ratio and represented 73.1% of plan assets.
9 Table 8 - Health Care Other Investment Costs
Other investment costs for the health care trust equated to a total fee ratio of 0.07%.
10 Table 9 - Pension Year-over-Year Comparison by Asset Class and Management Type
Note: YoY attribution effects of fund types within assets classes may not sum to the asset class value Table 10 - Pension Year-over-Year Comparison by Management Type
11 Table 11 - Pension Year-over-Year Comparison of Other Costs
Table 12 - Health Care Year-over-Year Comparison by Asset Class and Management Type
Note: YoY attribution effects of fund types within assets classes may not sum to the asset class value
Table 13 - Health Care Year-over-Year Comparison by Management Type
12 Table 14 - Health Care Year-over-Year Comparison of Other Costs
13 Analysis of Pension Year-over-Year Changes by Asset Class As presented in Table 9, the pension total plan fee ratio increased by about 54 bps from 1.12% in 2020 to 1.66% in 2021.
The largest driver of the increase from an asset class perspective were Private Markets (72 bps contribution), partially offset by Public Equity (-9 bps) and Market Neutral Strategy (-11 bps).
Analysis of Pension Year-over-Year Changes by Management Type and Other Costs As shown in the Table 10 YoY attribution section, benefits from changes in the management fee ratio (-12 bps) and lower manager- related operating expenses (-9bps) were largely offset by an increase in incentive fee ratio (69 bps)
As displayed in Table 11, Other Costs stayed the same at 0.07% in 2021 and 2020.
Analysis of Health Care Year-over-Year Changes by Asset Class, Management Type and Other Costs
As seen in Tables 12 and 13, the Health Care total plan fee ratio stayed consistent from 2020 to 2021 at 0.24% in 2020 due to changes in weight (2 bps) offset by lower operating expense ratio (-2 bps).
As displayed in Table 14, Other Costs remained increased slightly from 2020 to 2021 going from 6 bps to 7 bps.
14 Table 15 – California Government Code §7514.7 Disclosure, Private Equity/Venture Capital
Source: Fund managers, Meketa Investment Group
15 Table 16 – California Government Code §7514.7 Disclosure, Private Debt
Source: Fund managers, Meketa Investment Group
16 Table 17 – California Government Code §7514.7 Disclosure, Growth Real Estate/Core Real Estate
Source: Fund managers, Meketa Investment Group
17 Table 18 – California Government Code §7514.7 Disclosure, Private Real Assets
Source: Fund managers, Meketa Investment Group
Table 19 – California Government Code §7514.7 Disclosure, Hedge Funds
Source: Fund managers, State Street, ORS