To Cut Fees, Public Funds Seek to Take Charge of Investing

Investors responsible for more than $2 trillion recently gathered at a resort in the Canadian Rockies, far from the news media and, more important, far from Wall Street.

Those in attendance, including leaders of Abu Dhabi’s sovereign wealth fund and France’s pension system, were there to consider ways to put their money to work together without paying fees to private equity firms and hedge funds. Over that weekend, three of the attendees completed the details of a $300 million investment in a clean-energy company.

The group holding the gathering, the Institutional Investors Roundtable, has kept a low public profile since it began in 2011, but it attracted 27 funds managing public money to its latest meeting and is spinning off concrete investments. The group is part of a much broader push by the world’s biggest pension and sovereign wealth funds to reduce their reliance on the Wall Street firms that used to manage almost all their money.

The efforts to change the way public money is managed in places as far removed as Wisconsin and China are motivated, in no small part, by the big fees and lackluster performance that many hedge funds and private equity firms have delivered to their biggest clients in recent years. Investment managers like Leo de Bever, at the Canadian province of Alberta’s $70 billion fund, have found that they can often manage their own money at a lower cost without losing out on returns.

“The big investors are saying, ‘Wait a minute, we don’t have to do this anymore,’ ” said Mr. de Bever, chief executive of the Alberta Investment Management Corporation, which hosted the April meeting in the Rockies.

The moves are not yet threatening to eat into the overall profits of the big hedge funds and private equity firms that cater to large international investors. Even the funds that are graduating to investing alone generally say that they still use Wall Street firms for areas in which hiring an expert would be hard. But the moves point to a mistrust of Wall Street’s ability to deliver the kind of outsize returns it has long promised. This, in turn, is leading to a broader shift toward lower-cost methods of managing money.

For ordinary retirement savers, there has been a significant move away from expensive, actively managed mutual funds toward cheaper funds that passively track an index of stocks or bonds. Many sophisticated pension funds have been shifting to this sort of investing for years. Now, the big players are also searching for cheaper ways to put money into trickier investments like real estate and technology start-ups.

“Across the board, across every single asset class, we’ve seen movement toward saying, ‘We want more control over our assets,’ ” said Victoria Barbary, the director of the Sovereign Wealth Center in London, which tracks the national funds that manage public money in places like Singapore and Norway. “It’s all a response to wanting more control and not wanting to pay fees.”

When Mr. de Bever took the helm of the Alberta fund, known as Aimco, in 2008, it had relationships with about 50 private equity firms. It has since cut that number to 12, and all new investments are being made by an internal team that Mr. de Bever hired in Edmonton.

Aimco has found that it generally has to pay private equity firms about 6 percent of any assets they manage each year. When the work is brought in house, the expenses drop to about 1 percent.

Mr. de Bever occasionally hears grumbling from the sophisticated New York firms who doubt his fund’s investing ability, he said. “They should leave it to the pros,” he has heard the firms say.

But a research paper written by two Harvard Business School professors, Josh Lerner and Victoria Ivashina, found that private equity-style investments made by seven large funds generally outperformed those that the funds made through private equity firms. The paper is being reviewed for publication.

Steve Judge, the president of the Private Equity Growth Capital Council, said that “proven private equity firms deliver superior returns.”

“Those investing outside of traditional private equity partnerships will find it very challenging and expensive to recruit the talent and experience necessary to replicate those results,” Mr. Judge added.

Canadian funds like Aimco have led the shift toward direct investments, ever since the Ontario Teachers’ Pension Plan began building its own investing team in the 1990s. Public pension plans in the United States have been among the slowest to take up in-house investing largely because they can pay employees only public-sector salaries. That has limited their ability to hire people with investment experience.

In Wisconsin, though, the state’s $145 billion public pension fund, the nation’s ninth largest, is looking for an employee to run a new program that will make private equity investments directly rather than through a fund. The fund has estimated it will save $19.3 million in fees over the next five years on the $500 million that will be put to work.

“The market giveth and the market taketh away, and there’s not much we can control out there â€" but fees are one area where we can,” said Michael Williamson, the executive director of the State of Wisconsin Investment Board.

Over all, the Wisconsin fund is now managing 61 percent of its own money, up from 21 percent in 2007. Among the nation’s 200 largest pension funds, $932 billion was invested in-house last year, up from $787 billion in 2009, according to surveys by Pensions and Investments.

Wisconsin has been able to make changes because the Legislature voted to let the investment board pay higher salaries than other state agencies, including Wall Street-like bonuses. Oregon’s public pension fund has recently pushed for legislation that would allow it to do something similar, but that has faced opposition from public sector unions.

Recently, the most significant movement into in-house investing has come from the sovereign wealth funds that have been springing up in countries around the world. These funds are collectively estimated to hold about $4 trillion, and they often have fewer restrictions on how they invest than American pension funds.

Because there are so many new sovereign wealth funds, said Scott Kalb, the former chief investment officer of the Korea Investment Corporation, they are more able to question the old ways of doing business with Wall Street.

‘They are trying to set the terms of how they want to invest,” said Mr. Kalb, who now runs the Sovereign Investor Institute. “And they’ve got the firepower to do it.”

Many of these funds are beginning by making what are known as co-investments, in which they put money into a company alongside a private equity company without paying any fees. But the Institutional Investors Roundtable is one of a number of efforts to allow sovereign wealth funds to make co-investments with one another, capitalizing on the wider array of geographical expertise.

The round table is being run as a nonprofit and already has attracted two of the three largest sovereign wealth funds in the world: the China Investment Corporation and the Abu Dhabi Investment Authority. The group’s founder, the Canadian lawyer Christian Racicot, said that the meetings were meant to allow funds with less experience to learn from those with more.

At one of the round table’s early meetings, the China Investment Corporation and the Russia Direct Investment Fund discussed setting up what ended up being a $2 billion fund to make direct investments together.

The chief executive of the Russian fund, Kirill Dmitriev, said, “More and more there will be direct partnerships between different sovereign wealth funds.”

Mr. de Bever, at the Alberta fund, said that because Wall Street firms were not in attendance, the round table did not have the same fancy dinners and lush entertainment that were standard at conferences for funds like his. But he said that could be a good thing.

“The marketing and the wining and dining can get in the way of what needs to be done,” Mr. de Bever said. “This is about the people putting down their money, not the people who manage the money.”