Wednesday, April 16, 2014

Diversification has Its Limits: The Connection Between CALPERS and Momentive

Diversification has Its Limits: The Connection Between CALPERS and Momentive

Momentive Performance Materials Inc., a silicone and quartz producer, filed for bankruptcy on Sunday. The private equity firm Apollo Global owns the company, which it acquired from General Electric several years ago.  At first, I couldn’t find anything about this story worth researching or writing about.  From time to time, private equity sponsored deals go bust, especially when they’re highly leveraged in a commodity-like business. 

Yesterday I was studying CALPERS Annual Report and a recent presentation made to their investment committee on investment fees. I’ll have more to say about CALPERS investment fees in a few days.    As I was reading the report and scanning the almost endless list of managers, I thought about how diverse the pension’s investments appear to be.  CALPERS has hundred of managers covering every conceivable type of security and geography. 

For some reason, I started thinking about the Momentive bankruptcy and CALPERS.  Perhaps it’s CALPERS well-known relationship with Apollo Global Management that prompted me to make a connection. Obviously, CALPERS has exposure to Momentive’s equity through one or more of Apollo’s funds.  However, I wondered if CALPERS also had exposure to Momentive as a creditor.  I also thought about the potential conflicts as CALPERS’s financial interest in the equity and the debt of Momentive collide with one another.

I dug through the bankruptcy filing and found Exhibit A attached to a court filing by Momentive’s CFO.  The Exhibit lists seven unsecured creditors who had formed an ad hoc committee.[1]  It turns out that three of the seven members of that committee are managers for CALPERS and are significant creditors: Ares, GSO, and Oaktree.  By the way, this situation is not unique to CALPERS.  A quick check of New York Common Retirement, Oregon Retirement, CALSTRS, and North Carolina Retirement showed that they all have multiple exposures to the Momentive bankruptcy.

Moreover, according to Momentive’s most recent 10-K filing with the SEC, Apollo holds a significant amount to Momentive’s debt.[2]   So Apollo represents the equity and certain creditors.  Moreover, General Electric, which sold the business to Apollo, is a $742 million equity holding for CALPERS.  GE remains a minority owner[3] of and large creditor[4] to Momentive.  In addition, CALPERS’s annual list of holdings[5] shows that it also owns three of Momentive’s bonds.  Again, this situation isn’t unique to CALPERS.  Almost every major pension plan is going to have a wide variety of exposures to Momentive despite their attempts to diversify.  In addition, they are paying significant management fees, potentially carried interest, and a wide variety of fund expenses, to a series of managers who have all invested in the same company.

This result is entirely predictable.  If big pension plans try to deploy large amounts of capital into private equity, credit funds, and hedge funds, they are all going to wind up making commitments to the same universe of large managers who can handle big allocations.  The managers, in turn, will wind up deploying the capital in the equity and debt of companies that are large enough to absorb investments by large size funds.  As a result, big pension plans are going to wind up with multiple and conflicting exposures.  The apparent diversification created by hiring multiple managers is greatly undermined when those managers tend to pursue the same or similar investments.

After paying the fees and expenses for all the folks sitting around the table to sort out the Momentive bankruptcy, CALPERS and other institutional investors are likely to pay a fairly high price for this investment.

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