The San Diego firm that received $500 million in state pension investments from former state Treasurer Richard Moore — and that later hired Moore — collected a higher share of management fees last year than the other 25 companies that make stock investments for the pension.
North Carolina paid Relational Investors about $6.6 million last year — or 1.26 percent of the $525.7 million that the Teachers’ and State Employees’ Retirement System has invested with the company. That’s about five times the percentage that the average company got for managing stock investments from North Carolina’s pension fund.
Moore, the state treasurer for eight years, invested pension funds in Relational Investors in August 2008, about three months after he lost the Democratic gubernatorial primary to Bev Perdue. In April 2009, Moore went to work for Relational as a managing director.
Moore has not returned repeated calls from Carolina Journal seeking comment.
Moore previously has said that, before going to work at Relational, he got an informal advisory opinion from the executive director of the state Ethics Commission. Janet Cowell, Moore’s successor as state treasure, has established new rules requiring some former treasurer’s office employees to wait at least two years after they leave Cowell’s employment before they can do business with the state.
Ralph Whitworth, the founding director of Relational, said he met Moore after employees from the treasurer’s office performed due diligence on the state’s investment with Relational.
“It wasn’t like I had a relationship with him,” Whitworth said.
Relational Investors’ fund is a large cap fund, meaning it invests in large companies listed on the major stock market indexes.
Relational charges higher fees because it is an activist firm that tries to get value from its investments by pushing for change in the companies it invests in, Whitworth said. He and another director at Relational have served on the boards of 21 companies. Whitworth was the chairman of Waste Management when the company cleaned up an accounting scandal. He helped oust CEO Bob Nardelli at Home Depot.
“It’s not like someone sitting at Fidelity picking stocks,” Whitworth said. “That’s a much cheaper business model, as you can imagine.”
Edward Siedle, a former attorney with the U.S. Securities and Exchange Commission, said Relational’s fee is exceptionally high for large cap management.
Siedle, president of Benchmark Financial Services in Ocean Ridge, Fla., said a 2003 survey by his firm of 100 pension funds found that the median fee charged for large cap investments the size of North Carolina’s investment with Relational was well under 20 basis points. A basis point is 0.01 percent.
Siedle said an appropriate fee for a large cap investment would be 10 to 20 basis points, or up to 0.2 percent of the investment.
Fees in that range would have saved North Carolina’s pension fund more than $5.5 million last year in its investment with Relational.
“In order to justify paying hedge fund type fees for large cap the manager should substantially outperform the passive or index managers,” said Siedle.
T.J. Carlson, a principal at Ennis, Knupp & Associates of Chicago, said Relational’s fees were justified. In a memo that was dated after Carolina Journal had asked the treasurer’s office about the fees, Carlson said Relational’s fee schedule is “meaningfully and justifiably above those charged by the plan’s other traditional equity managers.”
Relational charges a 1.5 percent management fee and an incentive fee of 20 percent for outperforming the S&P 500 Index.
North Carolina is one of Relational’s largest clients. Whitworth said Relational charges the same fee to North Carolina as it does to its other clients. He said Relational’s fees are in the midrange for activist managers.
“This is the same fee that we have charged all our clients,” Whitworth said. “It’s not a special fee for North Carolina.”
Ardis Watkins, the legislative affairs director for the State Employees Association of North Carolina, said the fee is unacceptable.
“This type of thing keeps coming up, and the legacy of Richard Moore seems to be making money off of the retirees and the pension fund,” Watkins said.
Moore doesn’t have an ownership interest in Relational, but he may in the future, Whitworth said.
“Generally, when we bring people in at that level, we don’t make them owners until after a trial period of about three years,” Whitworth said.
North Carolina’s investment in Relational increased in value by about 26 percent last year.
Other funds the pension plan invests in posted similar returns and were paid much less in fees. Bank of America’s Large Cap Passive fund increased in value by about 26 percent but received $361,904 in fees, or 0.02 percent of the state’s investment in the fund. The Evergreen Large Cap Passive fund increased by about 26 percent and received a similar percentage in fees — $479,350.
Fees traditionally are lower at passive funds that mimic the performance of a benchmark fund. Such funds also traditionally do better than actively managed funds such as Relational during volatile periods in the stock market.
A recent study of the North Carolina treasurer’s office by Ennis, Knupp found that it uses passive funds less often than its peers.
The study found that about 12 percent, or $6.8 billion, of TSERS funds are invested passively. The average public pension fund that is larger than $20 billion invests about 22 percent of its portfolio passively.
The report recommended that North Carolina look at how much it allocates to passively managed funds.
Siedle observed that public pensions avoid high large cap management fees since it’s unlikely that a large cap manager with a high fee would outperform the index.
Whitworth said Relational’s performance over the last 15 years is 9 percent above the S&P 500.
“Our long-term performance is way in excess of the passive funds,” he said.
Relational claims on its website that its large cap fund has “materially outperformed” the S&P 500 Total Return Index on a cumulative basis from 1996 to March 2010, but the fund did not invest primarily in large-cap companies until July 2008.
Sarah Okeson is a contributor to Carolina Journal.
[EDITOR’S NOTE: This article was edited after initial publication to clarify Ralph Whitworth’s role at Waste Management.]