How CalPERS Private Equity Team May Have Been Captured
In the world of regulation, critics often suggest that regulators are prone to be captured by the industries they are supposed to regulate. The same charge is leveled at public pension officials, who often seem to reflect the values of money managers rather than pension beneficiaries. The CalPERS video of its most recent investment committee meeting provides a good illustration of an official being captured by the private equity industry. Again, I recommend that you read Naked Capitalism’s detailed discussion and at least watch the video excerpts. I’ll leave it you to judge whether the Managing Investment Director of Private Equity, Réal Desrochers, has maintained his independence, or whether he’s reflecting the views and values of the private equity industry.
In this post, I want to explain how capture occurs. At the outset, let’s dispense with the most obvious explanation of capture: a potential job with a private equity firm. While some public pension professionals wind up working for money managers, including private equity firms, the so-called revolving door isn’t a pervasive problem. Many public plans have restrictions on seeking post-employment opportunities in the private sector, and most pension executives never draw paychecks from the money managers.
Another common perception is that free meals, rounds of golf, or gifts are a common way of winning over public pension officials. While these practices create an improper impression and are banned by many public pensions, they aren’t a central part of influencing the decisions or capturing the business of a public pension plan. In my experience, those free dinners were actually a useful way of getting a couple of drinks into a money manager, and inducing him to reveal things that he’d never admit in a conference room.
In my view, capture is a more subtle process that occurs in two simple steps. First, most money managers are adept at stroking the egos of public pension officials. As I’ve mentioned on a couple of occasions in this blog, I was the smartest, funniest, most good-looking CIO until the day I resigned from the North Carolina pension plan. Money managers are adept at making pension officials believe that they’ve asked brilliant questions or extracted huge concessions, when in fact the question was lame and the concession was minor from the money manager’s standpoint. In the CalPERS video, you’ll hear Mr. Desrocher tout the fee concessions extracted by CalPERS under his leadership. In reality, the private equity managers have made small concessions on a product that is still grossly overpriced and riddled with hidden fees. Nonetheless, by granting these small concessions, the private equity industry has turned Mr. Desrocher and many other public pension officials into industry advocates.
Second, the success of the money manager and the pension professional are inextricably tied together. While public pension officials talk about due diligence and oversight, once a money manager is hired, a pension official’s objectivity begins to erode. Moreover, the impartiality may begin to erode during the due diligence process if a fund is oversubscribed. The public pension professional will feel pressure to woo the money manager in order to get an allocation to the hot fund. Over time, the pension professional becomes an advocate and defender of his decisions, including his roster of managers. This is especially true in private equity and real estate where there’s no easy way to fire a manager. Once the contract is signed, the pension official has committed the pension to a ten to fifteen year relationship, and his objectivity has been compromised.
What’s the best defense against capture? A strong staff and informed trustees. The CalPERS video strongly suggests that CalPERS is lacking on both fronts.