As readers may recall, our June 4 post broke the story that CalPERS Admits It Has No Idea What it is Paying in Private Equity Carry Fees. These fees are the biggest that CalPERS pays. The story got traction after it was taken up at the end of June and early July by the New York Times’ Dealbook, Dan Primack at Fortune (who depicted CalPERS as lying or suffering from a “massive breakdown in financial controls”) and then the Sacramento Bee. The SacBee article is particularly important in putting pressure on CalPERS, since the thing CalPERS is most afraid of is the California legislature, and the SacBee has clout with them.
We urged Naked Capitalism readers to call and write California State Treasurer John Chiang, who also sits on the CalPERS board. While at least 5 of CalPERS’ 13 board members are government officials , the State Treasurer is generally the most influential of them and is also an elected official, making him subject to voter concerns. Another plus is that unlike state legislators, state treasurers seldom get missives and calls from members of the great unwashed citizenry.
While the SacBee article no doubt did the most to get the attention of Treasurer Chiang, communiques from Naked Capitalism readers and other California voters would have helped persuade him that the issue of CalPERS’ lack of diligence in tracking expenses (the carry fees at issue are estimated by CalPERS board member JJ Jelincic as ranging between $600 million and $900 million in the last year) and broader governance issues were not going away.
The update from the Financial Times, in Calpers’ private equity problems pile up:
One of California’s most senior elected officials has voiced “great concern” at Calpers’ worrying admission that America’s largest public pension scheme has no idea how much it pays its private equity managers.
John Chiang, state treasurer of California, told FTfm he will demand clear answers from the $302bn pension plan over why it does not know how much has been paid in “carried interest” or investment profits over a period of 25 years to the private equity managers running Calpers’ assets.
The attack comes just weeks after US regulators issued an explicit warning to the private equity industry to expect more fines for overcharging investors….
“This issue is of great concern to me,” said Mr Chiang, who is a known reformer and also sits on Calpers’ administration board. “This will have my close attention until it is solved.”
This is a good start, but bear in mind that it is only a start. The fact that CalPERS didn’t get on board with collecting private equity carry feee data until it got bad press, and that Chiang is supporting the effort only after it’s been revealed that CalPERS’ staff has relented, says the underlying problems have not been solved. Chiang is now on board only after he doesn’t have to fight with CalPERS’ staff in a serious way. He is at looking at what they are already in the process of doing.
As we’ve documented, CalPERS is a large and particularly visible example of a pervasive problem among private equity investors: that they are afraid of and way too deferential to private equity funds, also known as general partners. That’s inexcusable for an investor as large and high profile as CalPERS, which has the authority to set standards and demand better conduct. Instead, this carry fee fiasco has revealed that CalPERS is if anything below industry norms. As Dan Primack recounted, other private equity limited partners were shocked at the lame excuses that CalPERS made for its failure to track carry fees.
There’s a deeper reason for CalPERS trying to shield the private equity industry. Remember, CalPERS and other private equity investors are so deeply captured that they routinely and reflexively side with private equity firms over the interests of their beneficiaries and the public at large, which amounts to neglecting their fiduciary duties. That’s because they believe the mythology that private equity outperforms other investment strategies. As we’ve discussed at some length, that’s false, and CalPERS’ own record confirms that. Private equity has underperformed CalPERS’ benchmarks for the last ten, five, three, and one years. And what has CalPERS’ response been? While it has cut its allocation to private equity, as we noted in April, CalPERS also lowered its private equity benchmarks to justify its lousy performance.
As the Financial Times reports:
Professor Ludovic Phalippou, a finance professor at the University of Oxford Saïd Business School, who specialises in private equity, said: “Calpers’ total bill is likely to be astronomical. People will choke when they see the true number.”
He added that if a sophisticated investor such as Calpers faced difficulties in obtaining accurate information, then it could only be harder for smaller pension funds, endowments and wealth managers that are less well resourced.
Mike Heale, a principal at CEM Benchmarking, a Toronto-based consultancy, said: “Less than half of the very substantial private equity costs incurred by US pension funds are currently being disclosed.”
Calpers has asked all its private equity managers to provide data on carried interest payments since their contracts with the pension fund started. So far, six of the managers employed by Calpers have declined to provide data for the current year.
Mr Phalippou said: “Private equity managers know what they charge and there is no reason for them not to disclose [this] to their investors.”
In other words, the reason that CalPERS has been less than inquisitive and forthcoming is due to the fact that it is a large enough private equity investor that its program has been treated in academic studies as a reasonable proxy for the entire private equity industry. Getting a better image of the total fees charged by private equity firms will make it far too obvious how unjustifiably extractive the industry is, particularly since private equity is also set up to be a “heads I win, tails you lose” form of investing. The private equity firms take so many fees that are unrelated to performance, and some that are related to pure churn, like transaction and financing fees, that they do extremely well irrespective of whether their investors make any money.
CalPERS is also suffers from serious corporate governance deficiencies. When board member JJ Jelincic made his inquiries about carry fees, he was both lied to and blown off by Chief Operating Investment Officer Wylie Tollette. As we described in detail, Tollette claimed that CalPERS not having the fee information was “an industry problem” when CalPERS had an outside consultant compiling this data as recently as 2011! And Tollette tried telling Jelincic that CalPERS was in the process of getting the information when its own written documents to the CalPERS board on its software development plans showed it wouldn’t have the new systems in place for some time (until the press furor, CalPERS’ position was that it needed to have the systems in place first, as if it was oh so difficult to keep the information in a spreadsheet in the meantime).
To put it more simply, it should not take a barrage of bad press for a board member to get truthful answers to questions and correction of obvious deficiencies.
So if you are in California, and particularly if you are a CalPERS beneficiary, it would really help if you’d keep Treasurer Chiang on the straight and narrow. Please call or write him:
Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
Tell him that you appreciate his willingness to keep CalPERS honest on the matter of carry fees, but that he needs to go much further. Describe how you are concerned that CalPERS seems to put loyalty to the private equity industry over its duties to retirees, and its staff has been resisted even mild oversight from the board. Stress that the CalPERS board needs to take its oversight duties far more seriously and press staff much harder for answers and action.
Update 3:00 PM: A reader reminded me that Chiang also sits on the board of CalSTRS, another very large investor in private equity. And as the SacBee article pointed out, CalSTRS’ posture on carry fees is arguably worse than CalPERS. While CalPERS has apparently never disputed the notion that private equity carry fees, a CalSTRS spokesperson depicted them as “not that important”. So readers who contact Chiang should also ask him to have CalSTRS adopt the same practices he wants CalPERS to implement.