Tuesday, September 2, 2014

Drawing the Wrong Inference: In-state Investing in NC

Drawing the Wrong Inference:  In-state Investing in NC

Last week the International Business Times tried to make the connection between an investment in Carousel Capital by the North Carolina Innovation Fund and contributions to the State Treasurer’s campaign.[1]  The IBT’s logic is as follows.  Erskine Bowles, former White House chief of staff, is a senior advisor to Carousel.  While he didn’t contribute to Treasurer Cowell’s campaign, his wife, Crandall Bowles, held a fundraiser for the Treasurer.  Shortly thereafter Carousel received an undisclosed commitment from the Innovation Fund in 2012. At first glance it seems that IBT’s reporter David Sirota may have hit upon a potential example of “pay-to-play.”

However, I think Mr. Sirota is looking for a connection that isn’t pertinent to the Innovation Fund’s investment in Carousel.  Moreover, Mr. Sirota’s charge diverts attention from more significant questions about the Innovation Fund. Let’s begin with the attempt to connect the fundraiser to the investment in Carousel.  For starters, Mr. Bowles doesn’t appear to have any economic interest in Carousel.  According to filings at the North Carolina Secretary of State’s office, he appears to have resigned as a member of the company in the late 1990s.  According to the filings, he never returned between his stints of public service.  In addition, Carousel’s filings with the Securities and Exchange Commission show that the firm’s managing directors and not Mr. Bowles have an economic interest in Carousel.  While Mr. Bowles continues to appear on Carousel’s website as a senior advisor, that seems to be more about public relations than anything else.

I think it would be far more enlightening to understand the more subtle aspects of political influence that transcend elections and campaign contributions.   Nelson Schwab III, a co-founder of Carousel, was Chairman of the Board of Trustees for the University of North Carolina when Erskine Bowles served as the President.  He’s been a member of the board of trustees for well over a decade.  In that and other civic roles, he’s had ample opportunity to get to know and work with all the major political figures in North Carolina, including Treasurer Cowell and former Treasurer Moore.  Thus it should come as no surprise that Carousel would be well positioned to get a favorable hearing from the pension plan.

Moreover, the state’s commitment to Carousel is nothing new.  The pension plan invested in Carousel’s third fund in 2006 under Treasurer Moore.  According to performance data released by the State Treasurer, Fund III had a return of 23.3% net of fees and 2.0 multiple.  Thus it’s not surprising that that the current Treasurer approved a commitment to Carousel’s Fund IV in 2012.   In fact, it’s the pension plan and not the North Carolina Innovation Fund that made the commitment.  The fees are fully disclosed for both Carousel funds.   In 2013, Fund III earned $16,000 in management fees and $1.2 million in carried interest.  Fund IV earned  $660,000 in management fees.

Mr. Sirota is right about two important facts.  It’s just that he’s jumped to the wrong conclusion about investments and campaign contributions.  The North Carolina Innovation Fund appears to have a relationship with Carousel separate from the State’s Fund IV investment.  Disturbingly, the nature of that relationship hasn’t been disclosed.  As I discussed last April, Grosvenor, the manager of the Innovation Fund, has made some far-fetched claims in seeking to shield the fund from public scrutiny (see, “A Place Where Further Scrutiny Is Warranted: In-State Investing [April 25, 2014]).”  This is particularly troubling since the State Treasurer exercises an unusual amount of control over the fund’s investments and the pension is the fund’s only outside investor.   For example, I think the public should know why the pension plan is paying Grosvenor a fee to oversee an investment like Carousel, when the pension already has conducted a lot of due diligence and has a direct relationship.  The same situation is true for Hatteras Fund, where the pension invested directly in 2007.

From the public’s perspective the Innovation fund is a black hole.  The Treasurer and her staff undoubtedly know the details, but the public ought to have some idea how much money has been invested directly in North Carolina companies and how much has been invested with fund managers.   Over the weekend I decided to visit the websites and peruse the legal filings of the eight fund managers listed on the Innovation Fund’s website.  Here’s what I learned:

·      Other than a couple of the smallest managers, many of the partners or managing directors are highly influential in North Carolina politics and civic matters, including Hugh McColl, Jr. and Marken Oken at Falfurias, Robert Ingram and Kenneth Lee at Hatteras, Ron Wooten at Novaquest, Edward McCarthy at River Cities, and Nelson Schwab.  During my tenure I met with a significant number of these folks although we didn’t invest with any of them.  They got plenty of opportunities to meet with me and my staff.

·      Among the 33 individuals listed as partners or managing directors (the folks who own the firm and make the investment decisions), there’s not one woman or minority.  This is a bit unusual for a pension plan that seeks diversity.

·      While the Innovation Fund states that its managers invest in North Carolina and the Southeast, the portfolio examples listed by the managers (not all of the managers provide examples), shows a much wider distribution of investments.  Perhaps the information on their websites isn’t indicative of the investments they make for the Innovation Fund.  However, the Innovation Fund’s lack of transparency means that we can only draw inferences from the managers.

The Innovation Fund is brilliantly constructed.  Every public pension plan in the country has some level of political and/or local influence at work.   Most every sole fiduciary and board of trustees has managers or investments that it would like to prod to the head of the list.  By placing investments inside the Innovation Fund, the State Treasurer can have the best of both worlds.  She can be an ardent advocate for transparency, but place the most politically sensitive investments behind the blackout curtain that is the Innovation Fund.

The Innovation Fund isn’t harboring hundreds of millions in undisclosed fees as some critics have charged.  The managers listed by the Innovation Fund have significant experience, and some if not all, might warrant investment by institutional investors.  However, the Innovation Fund avoids scrutiny where it is most needed.  In fact, a higher degree of disclosure is warranted because political influence is unavoidably pervasive.

[1] http://www.ibtimes.com/nc-pension-deal-how-wall-street-ends-getting-cash-meant-main-street-1669174

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