Monday, December 23, 2013

Non-Remedy Remedies

Non-Remedy Remedies

For the past couple of days, I’ve been examining a report issued[1] by the North Carolina State Treasurer about placement agents.  So far I’ve looked at the procedural recommendations, (see, “When Lawyers Manage Investments”) and the substantive findings (“Unbaked Bread”).   Today I’m going to explore the remedies and fee concessions obtained from eight of the nine managers discussed in the report, as well as the decision by one manager not to negotiate.[2]  I’m sure a great deal of work went into the report and investigation.  However, the remedies and monetary recoveries leave something to be desired.
Division of Labor (1999)

There’s virtually no substance to the four remedies negotiated by the pension plan.  The first remedy bans gifts to employees of the plan.  It’s not much of a sanction, since the Treasurer has already enacted a Code of Ethics that bans gifts from all money managers.  Next, the eight managers agreed to a ban gifts to charitable causes on behalf of an employee of the plan.  Again, the Code of Ethics has the same ban applied to all managers.

Then the eight managers agreed to a ban from using a placement agent to solicit new business from North Carolina.  This remedy should be called, “the money manager profit enhancement act.”  Since the managers already have a relationship with the State, they really don’t need a placement agent.  However, if they wanted to pay a placement agent a fee for this service, it would be their money and not the pension plan’s money going to waste.  The State is saving these eight managers from themselves.  It’s also worth pointing out that Angelo Gordon agreed to a ban on placement agents although they’d never used one.

The final remedy bans the eight managers from making campaign contributions to anyone running for the office of State Treasurer.  The SEC already limits campaign contributions by money managers to $350 or $150 depending on whether they can vote for the candidate.  This ban will save the eight firms some pocket change.  If the State Treasurer is worried about appearances, she shouldn’t take contributions, however small, from the pension’s     existing or prospective managers.

Refunds and Discounts

At the beginning of the report, the authors herald an estimated $15 million in refunds and discounts.[3]  These numbers don’t bear up under scrutiny.  For example, any money collected isn’t a refund.  The pension plan didn’t pay the placement agent; the managers did.   The report speculates that the fees might have been lower if the placement agents hadn’t been involved in the first place.  The pension plan collected the refunds because the managers wanted to keep their multi-million dollar relationships. 

The Retirement System failed to reach an agreement with C.B. Richard Ellis and as a result, the report states that the pension system “will not engage in any further business with CBRE in the future.”[4]  CBRE had no incentive to reach an agreement.  The investment, CBRE Strategic Partners IV, has generated an annual loss of 27.34% since 2005.[5]  Moreover, CBRE has already charged most of the fees it will receive, as Partners IV is beyond the investment period.[6]  In short, CBRE knew they weren’t going to be rehired anyway, so they had no incentive to reach a settlement. 

In the case of Avista, a private equity manager, the report says that the pension plan saved  $3.2 million because Avista will offer a 25BP discount if the pension decides to invest in Avista’s next fund.  I think there’s a very good chance that the pension plan would have gotten the discount anyway.  As a large, three-time investor this kind of fee concession wouldn’t be unusual.  In addition, the present value of the fee discount is significantly less that $3.2 million, since it would be realized over the next five to ten years.

The lion’s share of the refund claimed in the report is generated from Longview, a global equity manager, which agreed to pay $10 million through a quarterly $500,000 fee reduction.  This arrangement is a decent result for Longview.  While they could be terminated at any time, under this contract they need to remain a manager with the pension for five years in order for the pension plan to receive the full refund.   My guess is that Longview is making at least $5 million to $7 million a year in management fees.  Assuming no market appreciation, Longview will still generate $15 to $25 million after paying the “refund” over the next five years.[7]  I had to guess  at Longview’s fee arrangement because North Carolina does not disclose the fees it pays to managers.

Conclusion: After a four investigation the pension plan will be, according to the report’s math, richer by $15 million or a mere 0.018%.  I hope the various studies, consultants, lawyers, and other expenses put into this project didn’t cost more than $15 million.  Of course, those items aren’t disclosed, so we don’t know how much this special report has cost the pension plan. 

[2] C.B. Richard Ellis refused to settle.  
[3] Report, Tab1, page 3
[4] Report, Tab 2, Page 8
[5] Report, Tab 2, Page 17
[6] The management fee is usually cut in half at the end of the investment period.  The investment period is typically a five to seven year period during which a manager invests capital in deals or real estate.
[7] Earnest Partners agreed to rebate $660,000 in fees.  My guess is that they make about $1.3 to $1.5 million per year, and of course have made a lot of money over the past ten years.  Moreover, they manage a small piece of the North Carolina Supplemental Retirement Plan.[7]  So the rebate from Earnest was very modest.

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