Friday, April 25, 2014

A Place Where Further Scrutiny Is Warranted: In-State Investing

A Place Where Further Scrutiny Is Warranted: In State Investing

Please indulge my continuing commentary on the North Carolina pension plan, since Benchmark’s report offers so many opportunities to write about pension and investment-related matters.   As I’ve said from the outset, there are valid points embedded in Benchmark’s report about the North Carolina Pension Plan.  As a child I remember reading Aesop’s fable about the boy who cried wolf.  By issuing a report before the Treasurer completed releasing documents and by filling the report with numerous errors, Benchmark’s cries of wolf completely drown out legitimate issues.

The pension plan’s relationship with Credit Suisse (now Grosvenor because of a sale) is one such relationship worthy of further study and inquiry.  Credit Suisse was retained by the State Treasurer to run an entity called “The Innovation Fund.”  The Fund was designed to make investments in North Carolina businesses and investment funds.  Unfortunately, Mr. Siedle gums up the analysis by referencing legal proceedings against Credit Suisse that are completely irrelevant to the management of the pension plan’s assets.  Moreover, he references the fact that Credit Suisse is a significant employer in North Carolina.  Again, this bit of smoke obscures the real issues.

I’ve written repeatedly about the real and potential conflicts of interest in making investments in a pension’s home state.  I’ve also described my own involvement in these difficult situations when I was Chief Investment Officer and a consultant.  Public pension trustees are always under pressure to invest in their home state.  It doesn’t much matter if the pension is run by a sole fiduciary or a board.  If trustees don’t make investments in their home state, they are accused of “shipping the money to Wall Street.”  If they make investments in the their backyard, they are accused of making politically motivated investments.

From what I can tell, the Innovation Fund is Treasurer Cowell’s attempt to put a third-party in a position of evaluating North Carolina-based investment opportunities.  Given the limiting staffing at the Investment Division, the third-party manager gives the State Treasurer additional resources needed to evaluate the flood of in-state proposals that land on her desk.  I spent an enormous amount of time as CIO trying to understand, defuse, and dispose of in-state investment proposals.  In addition, I had to try to find a few reasonable opportunities in order to fend off the criticism that the pension’s fees were being shipped to New York or Boston.  While the Innovation Fund makes sense, Mr. Siedle correctly points out that it carries a sizable price tag and a certain amount of potential baggage.

The Innovation Fund isn’t like most other investments made by the State Treasurer.  In addition to its in-state focus, the pension plan is the sole limited partner, and the State Treasurer exercises far more control over the Innovation Fund than a regular private equity fund.  For example, under the terms of the partnership agreement the State Treasurer receives memoranda about and certain veto rights over every deal.[1]  In addition the management agreement provides that the fund will reimburse the pension for expenses incurred by the Investment Division’s staff if they conduct due diligence on an in-state investment.[2]  Most private equity deals don’t offer these features to their investors.

In my view, the public ought to get a great deal of information about the Innovation Fund because it is largely an extension of the Treasurer’s internal investment operation.  In my opinion, the State Treasurer shouldn’t be able to shield information from public disclosure by placing assets in a private investment vehicle and then have the manager claim that the information is shielded from public scrutiny.

Despite the fact that the Innovation Fund doesn’t have any other investors, Grosvenor has made all sorts of claims that severely limit the amount information disclosed under SEANC’s public records request.  The language in Grosvenor’s cover letter may make perfect sense to a licensed attorney, but it doesn’t make sense to me.  For example, Grosvenor claims that its fee structure is proprietary because it enables Grosvenor to attract clients, and its disclosure would cause Grosvenor economic harm.   This contention is as unsubstantiated as many of Mr. Seidle’s claims in his report.  Grosvenor has a completely customized relationship with a single public client.  The fee structure ought to be disclosed.  Grosvenor makes similar claims concerning expense allocations, governance and termination, and the underlying investments.  While some of the co-investments or direct investments might deserve protection because the disclosure would hurt the pension plan, SEANC’s request ought to be honored.

The arrogance and self-centered nature of many money managers is amply demonstrated by the unwarranted use of confidentiality and the over reliance on the trade secret exception to the public records law.  If I were State Treasurer, I would put all sorts of pressure on Grosvenor and other managers to make disclosures and eliminate the needlessly redacted documents.  Grosvenor’s position puts the Treasurer in an unnecessarily difficult spot and has created an opportunity for Mr. Siedle to make all sorts of negative insinuations. Having been the given the privilege and reward of managing money for North Carolina’s public pension, money managers ought to err on the side of public disclosure.  Of course, if money managers behaved responsibility I wouldn’t have much to write about.

In any event, SEANC is owed far greater disclosure about the terms, conditions, performance, and fees of the Innovation Fund and the other mandates managed under the Grosvenor/Credit Suisse umbrella.

[1] See Section 4 of the Partnership Agreement at  SSR-010172
[2] See Section 7.2(f) of the Partnership Agreement SSR-010183

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