Oxford has just posted professor Ludovic Phalippou’s “taster” presentation for his private equity class, using the same August Investment Committee meeting that we featured in our CalPERS’ Private Equity, Exposed series as a teaching tool.
This is a short and lively talk, since it is designed for MBA students who are new to private equity, and Phalippou gets very high marks from students for his lectures. It will be helpful both to readers who are new to private equity, since Phalippou explains how the biggest fees paid to private equity firms work, and to regular readers, since he makes quite a few of the “devil is in the details” features accessible.
It was a bit disappointing to see Oxford take the odd view that a video of a public board meeting that CalPERS put on YouTube and made freely embeddable to be copyrighted. Did all the members of the public who spoke assign their rights over to CalPERS?
We have the video clips and transcripts of the sections that Phalippou refers to here (with Priya Mathur) and here (with JJ Jelincic). But his presentation is completely comprehensible without seeing the underlying recordings.
You will note that Phalippou strives to be even-handed in his discussion. For instance, he goes to some length to point out that the example that CalPERS chose to present to the board of a fund presentation and the fees paid is representative, even when he creates a detailed model based for a “middle of the road” CalPERS fund. Nevertheless, some things still stand out:
1. The degree to which CalPERS’ staff seeks to minimize the magnitude of fees that private equity firms extract. Phalippou flags an obvious way in which CalPERS staff misled the board was misled regarding the amount of the biggest fee that investors like CalPERS pay to private equity general partners. CalPERS’ head of private equity Réal Desrochers kept claiming it was just like any other asset class, while Phalippou makes clear that private is the most expensive asset class, based on management fees (which Desrochers incorrectly depicted as being at the same level as for other asset classes) and in total, which Phalippou estimates at 7% per annum.
2. The degree of evasiveness and inconsistent positions taken by CalPERS staff
3. The amount of ground that Phalippou covered in his talk to MBA students that assumes they have no previous knowledge of private equity, versus the dumbed-down presentation given to CalPERS board members who are overseeing what is almost certainly the biggest private equity portfolio in the world. And that’s before you get to the poor questions some of the board members asked (we actually spared readers some of the worst in our CalPERS series, since it would have amounted to beating a dead horse). As a law professor who watched the August presentation wrote us:
It’s shocking to see how many of the CalPERS investment committee are utterly ignorant. wtf?! Aren’t these people supposed to know something?
Please take a few minutes to watch this instructive talk.
It always helps to remember that is is working class people who are getting ripped off here. When considering the many evils of our current financial system, the one I find most pernicious is how the human value of trust is turned on its head and exploited for criminal personal gain. Honest people by default will trust others they come in contact with. It’s a life view of trustworthy until proven guilty. A healthy society functions by this principle. Along with the rule of law equally applied to all citizens.
The financial elite have taken peoples natural sense of trust and cynically used that as a lever to further their stealing. They view us as suckers. I am reminded of a scene in Stephen Kings, The Green Mile. A great movie exploring the theme of Goodness confronting Evil in the world. John Coffey, a black man accused of the brutal murder of two young girls, recounts how the real killer accomplished the feat of removing the girls from their home without their parents knowing. The question was why did the girls not scream or make a sound? Coffey comes to know that the killer told each girl separately, that if they made a sound, he would kill the other. Coffey’s pain was the understanding that an evil man used the girls love for one another to murder them.
It is one thing to be caught in a individual act of graft, its quite another when major institutions or society at large are allowed to function as criminal organizations.
I don’t think the CalPers staff see themselves as a criminal organization. What they are doing is protecting their individual paychecks, pension, and institutional hierarchy–collectively. This is has become American culture personified.
Thanks for this post. It filled in some gaps in my understanding. I didn’t catch all the technical details but did get the gist. Paying 7% to as much as 9% a year in costs to general partners whether the market is going up or down. How footnotes in contracts are worded determines whether the limited partners are really paying 7% or 9%. How too many pension fund boards don’t track the total fees they’re paying.
This video is a short master class for Pension fund investment staff who maybe don’t really understand this either. They maybe rely too much on what PE general partners tell them.
Having a private equity firm manage a business that you own, is an awful lot like having a manager run a real estate property that you own. The owner “should” take due care that the manager does not “skim” assets that actually belong to the absentee landlord. Unfortunately for the property owner, the manager’s day-to-day closeness to and familiarity with the situation, gives him real advantages over the owner. If you’ve ever owned a home that you had to leave in someone else’s care for awhile after relocating, you have seen this movie.
Furthermore, for many P.E. managers, the temptation to skim may be even harder to resist than it is in real estate — businesses big enough to have been public companies at one time, are usually complex enough that they afford lots of opportunities for skimming. There are institutional investors — particularly insurers — who are known to be competent landlords. But as NC has shown, many P.E. investors have fallen prey to a far weaker mindset.
I do hope the law professor at the end was speaking in hyperbole.
As discussed above, Professor Phalippou is really only examining the tip of the iceberg. He is demonstrating the ignorance of CalPERS staff about the fees that they are actually being charged — which turn out to be 7-9% rather than the putative “2 and 20” that they think that they are being charged before items like foot-noted 100% claw-backs are factored into the sum.
The more deeply troubling problem is that if they can’t be bothered to do this simple arithmetic, how can they possibly be trusted to do the math on actual returns? Many big PE players are very cute about how they loot portfolio companies through asset sell-offs and strategic bankruptcy. However, often the entirety of the risk capital is provided by the Limited Partners, and the General Partners are simply acting as placement agents and asset managers. If the Limited Partners providing all the capital, shouldn’t they keep the all of the profits, less a reasonable management fee?
CalPERS staff clearly have no way of calculating what the actual profits were, and so have no way of determining whether placement and management fees are reasonable. They just sit there and obsequiously thank the PE industry for picking their pockets. During an investment conference, over a nice dinner at a nice hotel, no doubt…
Thank you for posting this very clear presentation (even through Professor Phalippou’s Languedoc accent).