Friday, June 16, 2017

How to bury a performance problem: A lesson from CalPERS

How to bury a performance problem:  A lesson from CalPERS

When an investment isn’t working out very well, the first step is to acknowledge the problem.  CalPERS has taken the opposite posture in addressing the shortfall in its private equity program.   Moreover they have engaged in the very behaviors that would require the average retail investor to fire her broker or financial advisor.  If one of CalPERS’s outside managers utilized one of these tactics they too would be terminated.

I won’t describe all of CalPERS misdeeds.   Rather I suggest you read the work of Naked Capitalism[1].  It is the only media source that has consistently investigated the performance of CalPERS private equity program.  The Sacramento Bee, Los Angeles Times, Pensions and Investments and few other publications occasionally provide some coverage, but no one else has done the detailed work required to expose CalPERS’ systematic attempt to avoid addressing the poor performance of their PE program.  In addition, you can find a series of posts on this subject on my blog.[2]

In the first ten years of my investment career I learned about the three inappropriate ways to address a problem of investment performance.  I’m ashamed to admit that in my private sector career I occasionally relied on two of these methods rather than confronting the issue with a client.   Once or twice when my investment performance for a client lagged badly, I resorted to confronting a critic or proposing a new benchmark.  CalPERS has used both methods to distract from its underperformance, plus one more tactic.  Unfortunately, the beneficiaries of the CalPERS defined benefit plan cannot find another investment manager.  However, if your broker or portfolio manager tries any of the tactics described below, find another advisor.

Rather than accepting poor performance, attack your critic.  If a consultant or board member raises concerns about performance, make that person or organization a target.  This tactic will not only deflect attention, it will also intimidate other board members or advisors from asking hard questions about the performance shortfall.  The outspoken board member JJ Jelincic fell victim to this tactic.  He was harassed, censured, and vilified before he finally deciding not to stand for re-election to the CalPERS board.

Instead of admitting to poor performance, change the benchmark.  If the investment performance of a money manger or an asset class, such as private equity, trails the benchmark, attack the benchmark.   The idea is to excuse failure by impugning the standard of comparison.  The staff and consultants at CalPERS have been trying to tell its board and the public that the shortfall in performance is largely the result of a benchmark that isn’t appropriate.  Ironically those are some of the same professionals who proposed the benchmark in the first place.

To further obscure bad performance, change around the asset classes, known in the industry as “buckets”.  In the case of CalPERS, they want to combine public and private equity into one big bucket.  The idea is to bury their PE problem in a much bigger pool of assets.  CalPERS is not alone in adopting this strategy; a number of pensions, including North Carolina, have tampered with their buckets in order to make proper evaluation of their investments much more difficult.

The beneficiaries of CalPERS do not have an advocate challenging the performance of private equity.  The pension’s investment professionals, consultants, and board members have aligned to bury the problem.  This is how America’s leading pension plan has become a laggard.

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