Monday, September 28, 2015

Another Private Equity Blunder in Sacramento: CalSTRS and its Consultant

Another Private Equity Blunder in Sacramento: CalSTRS and its Consultant

After thirty-five years in and around the money management business, I thought I’d seen every possible response to poor investment performance.  Managers and consultants have blamed market conditions, a bit of bad timing, and particular benchmarks.  Naked Capitalism has come through again with a disturbing piece of video showing a well-known consultant advising the second largest public pension plan to ignore its private equity benchmark altogether.[1]  I’ve never seen anyone advise an institutional investor to eliminate a benchmark as a response to poor relative performance.



I’m referring to PCA, a PE consultant, and the California State Teachers’ Retirement System (CalSTRS), which has $184 billion in total assets and $18 billion in private equity exposure.  In the most recent investment meeting at CalSTRS, Mike Moy, the consultant, stated that the pension plan had underperformed its PE benchmark for most reporting periods (see exhibit 1) and then suggested that the asset class shouldn’t be measured against any benchmark.  In the video, he suggests that CalSTRS should only judge private equity’s performance on an absolute return basis.  In other works, Mr. Moy is suggesting that the trustees accept the performance from their PE portfolio so long as they are satisfied that it is helping them meet their financial objective.  Naked Capitalism has meticulously exposed the absurdity of the consultant’s position. 

Exhibit 1


Private equity is a major, mainstream asset class in most institutional portfolios.  Moreover, as the name implies it is simply the ownership of common stock in companies that are not publicly traded.  As a result, the benchmark is straightforward.  Pick a major stock index like the S&P 500 and add a hefty premium (5% to 8%) to reflect the additional risk and illiquidity of PE.  In other words, if large public stocks return 8%, you should expect PE to return 13% to 16% net of all fees over the long term. 

There’s no doubt that the performance of a PE portfolio will vary from the returns of the public markets over short time periods, given the nature of PE accounting and the internal rate of return calculation used to calculate performance.  However, if an institutional investor isn’t getting a big premium over the S&P 500 from its PE portfolio over ten year periods, it’s a sign that something is wrong, and the problem isn’t the benchmark.  Ironically, the problem at CalSTRS is even more dire because their benchmark doesn’t have a big enough premium.  They only require their PE portfolio to exceed the S&P 500 by 3% to 4%.  It’s an expectation that you might be appropriate for small cap public stocks, but not private equity.

I’m not privy to the details of the CalSTRS private equity program, so I can’t tell you why it failed to beat its benchmark.  However, the board ought to be considering one or more of the following causes rather than eliminating the benchmark:

  •       The fees and expenses charged by CalSTRS’s PE managers have consumed too big a portion of the returns.  As best I can tell, CalSTRS’s fee disclosure for PE is among the worst in the country.  The pension’s annual report doesn’t even disclose management fees, let alone carried interest.[2]

  •       CalSTRS picked the wrong group of PE managers.

  •       CalSTRS didn’t properly pace its PE investments and has too big an exposure to certain periods of time when PE performed poorly.  According to CalSTRS’s latest quarterly report on PE, this is certainly part of the story.  CalSTRS invested far too heavily in 2005-2008 (see Exhibit 2).

  •       Its consultant has poorly advised CalSTRS.


Exhibit 2

Taxpayers and beneficiaries ought to be concerned about this state of affairs because CalSTRS has $9.5 billion in additional capital (see Exhibit 3[3]) to invest during a period when PE deals are grossly overpriced (see Exhibit 4).  Not only is CalSTRS likely to underperform its benchmark, it is also likely to produce anemic results based on PCA’s ill-advised absolute return standard.

Exhibit 3
Exhibit 4

A few weeks ago I wrote about CalPERS’s PE program.   Now we have evidence that the operation and performance of CalSTRS’s PE program is also problematic.  America’s two largest public pensions share PCA as their PE consultant.   Both plans ought to be taking a critical look at their PE programs.  Before that can happen they need to find a new private equity consultant.



[1] http://www.nakedcapitalism.com/2015/09/private-equity-underperformance-denialist-pension-consulting-alliance-tells-calstrs-to-fix-performance-problems-by-scrapping-benchmark.html
[3] The unfunded commitment is the difference between the two figures shown in Exhibit 3

Wednesday, September 16, 2015

Kentucky Retirement System is Still Translucent and Off Course

Kentucky Retirement System is Still Translucent and Off Course

About a year ago I wrote about the poor record of performance and disclosure at the Kentucky Retirement System (“The Art of Translucency” August 25, 2014[1]).  It took KRS twelve months, but they’ve finally gotten a bit more transparent about the fees they are incurring.  In fiscal 2014 KRS reported $46.3 million in fees, which was ridiculously low.  Why?  KRS didn’t include the management fees paid to private equity managers.  They simply chose to hide them. This year, KRS has revealed that the fees for 2015 were $80.4 million and has intimated that they paid a similar amount in 2014.[2]  The KRS trustees don’t deserve any credit for taking this step.  All they’ve done is reached the level of disclosure of the average pension plan.



The trustees also retained CEM benchmarking to evaluate the performance and fees of KRS’s investment program in the past five years.[3]  In exchange for its big bet on alternative investments, KRS achieved an 8.2% return versus 9.8% for the median public pension plan and 9.2% against its peers. KRS’s strategies and managers cost the plan 1% in net value per year, and its average management fee was 0.82% versus benchmark costs of 0.75%.  In short, they paid higher than average fees and got substantially poorer performance.

I think there are three take-aways from KRS’s recent reports.  First, KRS has only achieved a small degree of additional transparency.  Like any other pension plan seriously committed to alternatives, KRS incurs all sorts of hidden fees (carried interest, monitoring fees, etc.).  KRS isn’t disclosing any of those numbers, which would probably double the pension’s reported fees.

Second, KRS didn’t need the CEM report to tell them they were underperforming, while incurring above average expenses.  The trustees need only have looked at publicly available data and their own internal reports.  However, trustees have a long history of hiring consultants to tell them what they either already know or should know if they were doing their jobs.

Third, the CEM report reveals the entirely predictable point that the average pension plan’s asset allocation and manager selection do not add any value whatsoever.  Obviously, some pension plans add a bit of value in a given year and others detract value, but on average all the asset allocation strategies and manager searches yield nothing, unless, of course, you are a money manager or consultant.  The winners and losers aren’t the by-product of skill or a lack of skill.  Rather, adding or subtracting value is merely a random phenomenon.

Thus Kentucky and every other pension plan would be best served by resisting the marketing pitches of the alternative investment community, driving down investment expenses, and negotiating hard on fees. 



[1] http://meditationonmoneymanagement.blogspot.com/2014/08/the-art-of-translucency-kentucky.html
[2] https://kyret.ky.gov/Committee%20Meeting%20Action%20Items/2015-09-10%20board%20materials.pdf
[3] https://www.documentcloud.org/documents/2423226-kentucky-retirement-systems-consultants-report.html

Monday, September 14, 2015

Three New Gicleés for Sale and Two Third Edition Printings

Contact: asilton@nc.rr.com for details
Nocturnal Straight (11 x 17) 2015

Spirits (11 x 11) 2015

Tropical Wings (9 x 12) 2015

Imagining Alaska (22 x 28) 2014 3rd Printing

Icy Straight (9 x 12) 2014 3rd Printing


Tuesday, September 8, 2015

The Deeper Issues of the CalPERS Private Equity Failure

The Deeper Issues of the CalPERS Private Equity Failure


I was going to continue my critique of CALPERS’s private equity team because there’s much about the presentation at the most recent Investment Committee by the Chief Investment Officer, Managing Investment Director of Private Equity, and Investor Director for Private Equity that was simply incorrect.  However, there’s a more important point that’s been bothering me ever since Naked Capitalism directed my attention to the video of the meeting.



Shortly after North Carolina enacted a law in 2001 to allow the public pension to make significant investments in private equity, former Treasurer Richard Moore encouraged me to contact the private equity team at CalPERS.  He wanted to know everything I could find out about how CalPERS developed policies, negotiated deal terms, and conducted due diligence.  The CIO and staff (all of whom left CalPERS many years ago) were extremely generous with their time and shared all sorts of documents.  Treasurer Moore was eager to absorb this information because CalPERS was perceived to be the leading public fund investor in private equity with over a decade’s worth of experience.

Over the years, many institutional investors have looked up to CalPERS as a leading authority on investment policy, due diligence, and transparency.  If CalPERS signed on to a particular private equity fund, many investors assumed that the legal documents and economic terms had been aggressively and competently negotiated.  For small institutions and public funds with limited resources, CalPERS’s involvement in private equity was a source of comfort.

The performance of Ted Eliopoulis, Réal Desrochers, and Christine Gogan before the Investment Committee at the August and prior meetings has greatly undermined CalPERS’s reputation.    To be clear, I am not talking about CalPERS’s ability to select top performing private equity funds.  I don’t think there are many investors who can put together a portfolio of top performing funds.  There’s simply too much luck (noise) involved in predicting which funds will perform well in the future.  Moreover at CalPERS’s immense scale, the best CalPERS can hope for is to build a portfolio of private equity funds that delivers market performance.  In order to build a $30 billion private equity portfolio, CalPERS has to select so many managers and funds that it is virtually impossible to generate anything more than the market’s overall return for the asset class. 

Like any large investor, CalPERS must systematically attack every sort of fee and vigorously negotiate deal terms.  These are the only two techniques that can give a large institution marginally better performance and control over its private equity program.  Clearly, the current team at CalPERS has failed to do both.  As Naked Capitalism  points out, the investment team is still under the illusion that it can generate superior performance.[1]

For those of us who think it is important for institutional investors to stand up to private equity, the developments detailed by Naked Capitalism are very bad news.





[1] http://www.nakedcapitalism.com/2015/09/calpers-chief-investment-officer-invokes-false-superior-returns-excuse-to-justify-fealty-to-private-equity.html

Tuesday, September 1, 2015

How CalPERS Private Equity Team May Have Been Captured

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[1] 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.[2]  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.



[1] https://www.youtube.com/watch?v=VN1HkGTWk5U&feature=em-uploademail
[2] http://www.nakedcapitalism.com