We reported yesterday that CalPERS, the giant California public pension fund, is scrambling to collect information from private equity firms It’s not hard to suspect that the reason that CalPERS was on self-imposed forced march was that it got wind of the fact that the Sacramento Bee was working on a story about its failure to gather carry fees and include it in its metrics. The one thing that CalPERS fears is the California legislature. The Sacramento Bee carries more weight with them than any other media source, including national papers like the New York Times and the Wall Street Journal.
So while it was encouraging to see the SacBee publish the story, CalPERS tries to get handle on management fees, it’s also frustrating to see how much they dumbed down the reporting. The paper calls the fees at issue “management fees” when the “management fee” is the prototypical 2% in the “2 and 20” formula. The “carry fee” is the 20, for 20% of profits, usually over a hurdle rate of 8%. So it fails to convey even the basics correctly that CalPERS is missing the biggest type of fees it pays (as much as $900 million in the last year, which the article does point out). It does mention “base” fees, which are presumably management fees, of $441 million, but isn’t clued in enough to recognize that that figure is understated too. As board member JJ Jelincic has pointed out, CalPERS tracks only the fees it pays to private equity firms directly, when those direct fees are reduced by being shifted on the portfolio companies (see this post for more detail). Unlike the carry fees, it’s trivial for CalPERS to compute and record the management fees it pays directly and indirectly, since they are set forth in its investment agreements.
The story also gives undue prominence to Edward Siedle, who is in the process of attempting to raise money to “audit” CalPERS. The information needed to get to the bottom of what is going on with private equity fees and costs is at the portfolio company level, that is the companies owned by the private equity funds and effectively controlled by the private equity managers (the “general partners”). Investors like CalPERS don’t have access to this information, and worse, outsiders can’t get to much of the informational crumbs that limited partners like CalPERS are allowed to have because that’s shielded from the public by being exempted from FOIA in every state either by statutes that the PE firms got passed or by favorable attorney opinion. So it is hard to fathom what Siedle can do that would make any difference, particularly in light of the fact that Jelincic has already been exposed some important CalPERS dirty linen.
The article refers to the ruckus made by “financial bloggers”. I can see Naked Capitalism being relegated to the status of A Blog That Must Not Be Named, but what about Dan Primack at MSM outlet Fortune? He’s the one who blew the story open and described in gory detail why CalPERS’ defenses were lame.
The SacBee also may have been artfully misdirected by CalPERS. Recall that it’s big excuse was that it’s supposed inability to get carry fees was an industry problem. Primack found that limited partners were stunned that CalPERS would make that claim. Yet the SacBee picks it up and provides some corroborating evidence:
But many institutional investors, not just CalPERS, don’t know or don’t disclose how much they pay in performance fees to their private equity managers.
Ricardo Duran, a spokesman for the California State Teachers’ Retirement System, said CalSTRS can estimate the fees “within a couple of percentage points” but doesn’t report the figure.
“It’s not a number that we track,” Duran said. “It’s not that important to us as a measure of performance.”
Why is this quote from CalSTRS, an almost-as-ginormous pension fund as CalPERS, less convincing that it appears? Because the current Senior Investment Officer responsible for private equity, Réal Desrochers, recently held the same job at CalSTRS! The laxness about gathering fees at two supposedly leading institutions are the doings of Desrochers, who has a reputation in the industry for being controlling.
And as test of reader critical thinking skills, consider the close of the story:
Leaders of the private equity industry wouldn’t comment directly on CalPERS, but said big institutional investors understand the fees they’re paying.
“Limited partners such as CalPERS are among the most sophisticated investors in the world,” said James Maloney, spokesman for the Private Equity Growth Capital Council, a Washington trade organization. “They understand the investments they’re making, including detailed fund terms. They go through their agreements line by line.”
Do you see what’s wrong here? The Private Equity Growth Capital Council is a lobbying group for the private equity general partners. No one in it has ever sat in on a CalPERS review and negotiation to say that they review the agreements “line by line,” much the less even carefully. These agreements are so complex that much of the review is relegated to outside counsel. Yet as we’ve discussed repeatedly, limited partners like CalPERS can’t get adequate representation because any law firm worth its salt wants to be working (or in most cases is already working for) the general partners. They don’t want to break a much bigger actual or potential rice bowl by negotiating all that hard.
But more important, the contracts themselves have nothing to do with the issue at hand. While CalPERS was not getting the carry fee information broken out, but that it could be derived with a good degree of accuracy without too much work and could also be requested from the general partners.
But even though this article is far less forceful than the underlying facts warrant, CalPERS is highly sensitive to what it regards as unfavorable press, most of all from the SacBee. So this is a step in the right direction.
And even better, it will give even more credibility to letters and e-mails from CalPERS beneficiaries and California residents about the sorry state of CalPERS’ corporate governance and financial reporting. As we urged yesterday:
I hope all readers in California, particularly those who are current or future CalPERS beneficiaries, will call or better yet write their state legislator about the financial reporting and governance failings at CalPERS. You can find the contact information for state senators and assemblymen here. Be sure to send a carbon copy to the Treasurer John Chiang, who also sits on the CalPERS board:
Mr. John Chiang
California State Treasurer
Post Office Box 942809
Sacramento, CA 94209-0001
Or call his office at (916) 653-2995.
In addition, if you belong to a union, contact your representative and encourage him or her to bring these lapses to the legislature. And finally, e-mail Jon Ortiz, who publishes the at firstname.lastname@example.org. Please let us know what responses you get in the comments section of this post.
Stress that CalPERS hasn’t been honest and forthcoming when asked reasonable questions about private equity, acts only when subjected to considerable pressure, and demonstrates that all it is willing to do is make the immediate problem go away. CalPERS needs to address the underlying pathology, that it is putting its fear of rocking the boat with private equity kingpins over its fiduciary duty to beneficiaries.