Misconceptions Over Investment Terms Can Plague Advisors Large and Small

The environment for financial advisors is as challenging as I’ve ever seen it—including the limited partnership implosion of 1986. Even though advisory firm revenues have been rising in tandem with the stock market (which, of course, can’t continue to go up and may have recently peaked), there are myriad social trends that aren’t so promising.

Since 2008, the public trust of financial companies has been at an all-time low; academics such as Yale University’s Ian Ayres are claiming that management fees higher than an ETF’s are excessive; advisory fees are feeling downside pressure from robo-advisors; regulators and “professional” organizations seem to be cracking down on independent advisors in an effort to appear to be “doing something” and possibly diverting attention away from Wall Street. Even sorting out all these issues is a challenge, since the media seems to be way more focused on hype than facts. 

I recently came across a case that involves a number of these issues and offers a few lessons for independent advisors. The lessons include the importance of being able to clearly articulate the nature of risk and its relationship to returns, how to assess the success of investment performance and how to determine the “fairness” of compensation.

Readers who live in Southern California will have heard about the recent controversy involving the San Diego County Employees Retirement Association (SDCERA), which manages some $10 billion in retirement assets for more than 38,000 current and former county employees. 

Last June, the SDCERA board of directors hired Houston-based Salient Partners LP to be the asset manager of the pension fund. During the past month, some SDCERA board members have become disenchanted with Salient and its founder, Lee Partridge, claiming their management has taken too much risk for too low performance at too high a cost in management fees. 

Here’s the backstory. Salient had served as a paid consultant to the SDCERA pension fund since 2009. During that time, according to a recent Salient statement, the pension fund generated “a 10.1% annualized net return, which delivered $4.4 billion to SDCERA plan members at a lower cost and with less risk than 80% of similarly sized pension plans. The average SDCERA plan beneficiary realized more than $111,000 in gains under Mr. Partridge’s stewardship for a total fee over five years of $414 [per beneficiary].” The release also pointed out that “Mr. Partridge was awarded Small Public Fund Manager of the Year by Institutional Investor in 2012 for the outstanding results achieved with SDCERA.”

According to an October 2 posting on the local newspaper U-T San Diego Online, the SDCERA board was sufficiently impressed with Salient’s performance that “In April, the board unanimously endorsed [ Partridge’s] complex strategy.” And in June, according to a Sept. 11 CIO.com article, the board approved full outsourcing of its $9.9 billion portfolio to Salient Partners.

The new contract sets Salient’s annual fee at 11.5 basis points on AUM for the first six months and 10 basis points after that. Salient agreed to employ SDCERA’s three investment staff members as part of the deal, and all have accepted the offer.” 

But things have soured since then with some of SDCERA’s board members who had become uncomfortable with the leverage Salient was using, even though the firm’s tactics here the same as it had been using for the past five years, and which had received that vote of confidence last April.

Yet the same CIO.com story quoted one of Salient’s leading critics, trustee Samantha Begovich, (who joined the board in July, following its signing of the new contract) during a September 4 meeting: “At a time when pension managers are getting paid less and less across the board, it is well documented that we’re paying exorbitant, outlier-type fees with no incentives except to grow the fund.  Why is the contract fixed without any correlation to performance?” Perhaps I’m missing something here, but doesn’t performance “grow” the fund?