LPs only report half of costs
Only half of total investment management costs are included in LP financial statements, meaning tens of billions of dollars are unaccounted for.
The finding comes from an analysis carried out by CEM Benchmarking, for Top1000Funds.com.
The findings were based on cost and performance data from 300 global pension and sovereign wealth funds, representing $9.3trn in assets. The data was collected over a 28-year period by CEM’s database, as well as a recent study of financial reporting disclosure practices of 24 global funds, representing $4.4trn in assets.
The report’s authors Sandy Halim and Mike Reid (both from CEM) said, “We believe our estimate that 49% of costs go unreported in financial statements of annual reports is conservative and the extent of under-reporting is likely to be higher across the entire industry.”
The authors note the challenges of using averages when reporting costs. “Some report 80% or more of their true costs, others, less than 30%.”
CEM attributed the wide discrepancies to accounting standards because they provide lots of room for interpretation. While most standards require the disclosure of all invoiced investment costs, there are still inconsistencies and large amounts of unreported costs.
CEM identified three key problem areas when it comes to inconsistencies in annual reports.
- Pooled investments
- Private market investments
- Transaction costs
CEM cites the differences in how pooled investment funds reports compared with separate managed accounts. Pooled investment funds subtract fees from their returns, whereas separate accounts tend to invoice directly. Therefore, costs appear differently depending on the fund structure.
Base manager fees were identified as problematic because they: “Are often invoiced and reported after netting offsets and rebates representing fees paid to the General Partner from portfolio companies.”
The authors said: “CEM believes that the portion of these charges kept by the GP should be included as an additional cost and the portion rebated to the LP should not be used to offset base fees. Why? Because base fees are payable regardless of transactions with portfolio companies and the GP keeps its share of offsets and rebates.”
CEM found that carry is “often poorly reported, if reported at all.” The report pointed to a lack of consensus around whether or not carried interest is deemed as a cost, with some LPs believing it to be a form of profit, and therefore not a cost.
A lack of global standards has been identified as the issue here. While the UK, the Netherlands and Australian regulators now require more disclosure regarding transaction costs, the rest of the world is still yet to catch up. According to CEM, transaction costs alone can represent 20% of total investment costs.
CEM notes that another issue around transaction costs is the inconsistency in terms of what should or shouldn’t be included in the reports.
In conclusion, CEM suggested accounting standard boards should consider how current rules and practices have resulted in discrepancies and incomparable data in asset owner reports. However, they also noted that some larger asset owners do go above and beyond the minimal requirements. “Transparent, clear, and complete cost disclosure is just one aspect of a good annual report, but an important one,“ they said.