We Won a Fight Against CalPERS Over Its Plan to Ignore Private Equity Risk

Honestly, I’m still amazed we prevailed, since usually by the time powerful and insular organizations like CalPERS are ready to implement new (bad) policies, the scheme is too far advanced to be halted.

On Monday, December 7, we saw a remarkable agenda item on CalPERS’ website that was set for a vote at the Investment Committee meeting the following Monday December 14. Here’s the overview from our post on Friday, based on our Bloomberg op-ed that ran last Thursday, December 10:

What would you think if a pension fund responsible for 1.7 million beneficiaries said it was going to stop considering the the riskiness of one of its biggest investments?

Incredibly, that’s what the board of the California Public Employees’ Retirement System, America’s biggest public pension fund, might do on Dec. 14. One item on its meeting agenda would eliminate the strategic objective to “maximize risk-adjusted rates of return” on private equity, which involves using large amounts of debt to buy out companies with the aim of reselling them at a profit. This is a major policy change, engineered by the people who manage Calpers’s private equity investments.

Pay attention, because this is a case study in how CaLPERS’ staff manipulates the board to its own advantage.

CalPERS is apparently making this change in response to its poor performance in private equity over the last ten years. So CalPERS is acting like a fat person who decides to throw out the scale rather than look at its weight problem. And its enabler, its private equity consultant Pension Consulting Alliance (“PCA”) hasn’t even attempted to muster an intellectual justification to the board for this change. In a September board meeting at CalPERS’s Sacramento sister, CalSTRS, another PCA client, the account manager for both funds, Mike Moy, blandly acknowledged that private equity investors have a performance problem but then blamed the benchmarks!

Alert readers may notice the very short time frame between when we saw the astonishing CalPERS planned policy change, and when Bloomberg ran our op-ed. We are very grateful for our editor at Bloomberg, Mark Whitehouse, understanding the time time sensitivity of this matter, persuading the higher ups to consider and run our piece soon enough for it to inform discussion, and for doing his usual exemplary job of editing (and diligent fact checking!).

We also alerted our contacts, in particular our journalism allies, particularly the ones who have been concerned about the way limited partners like CalPERS have continued to circle the wagons with private equity general partners. That has continued in the face of the SEC telling them, in the words of former enforcement chief, Andrew Bowden, that they were having their pockets picked, as their own performance records showed that they had not been earning enough in the way of returns over the last ten years to justify the risks of investing in private equity.

Some of our colleagues in turn were so gobsmacked by the combination of audacity and stealthiness of CalPERS’ scheme that they started sending alarms to people in their networks.

While some were genuinely frustrated that they were already jammed and could not turn around an article before the CalPERS vote on Monday, others were able to saddle up. Dean Starkman of the Los Angeles Times, who had reported skeptically on CalPERS’ carry fee disclosures on November 25 (CalPERS fee disclosure raises question of whether private equity returns are worth it) worked with Melody Jacobesn on a story that ran yesterday morning, Calpers is set to change private equity policy.* Chris Flood of the Financial Times also worked in a mention of the pending policy change at the end of his story on a new study that quantified some of private equity’s hidden fees.

But a key effort came from Eileen Appelbaum and Rosemary Batt, the co-authors of the highly respected book Private Equity at Work. They placed an op-ed at the Sacramento Bee, which ran in its print edition Monday morning, right before the board vote. The two things that CalPERS is afraid of are the Sacramento Bee and the state legislature.

CalPERS apparently demanded a retraction but neither the SacBee nor Appelbuam and Batt backed down. CalPERS’ argument boiled down to claiming that they weren’t eliminating the private equity benchmark in the Monday vote. But it was not hard for independent parties to see the game CalPERS was playing. By eliminating the policy language that returns be risk adjusted today, they could axe the risk-adjusted benchmark in 2016 when they review and revise all their benchmarks.

I saw most of germane section of the board meeting today (unfortunately I got a phone call at the wrong time, so I did not see it all). The CalPERS staff came in signaling that they were prepared to give ground. Remarkably, the board actually had a discussion of issues, something that rarely happens. The Los Angeles Times, in CalPERS shelves controversial private equity policy, gave a recap:

The state’s biggest public pension fund has repeatedly missed a key performance goal for its controversial private equity investments.

But a CalPERS committee said Monday that the fund’s staff could not strip language from a written policy that required them to aim to meet that benchmark – returns roughly 3% higher than the stock market to compensate for private equity’s risk.

By voice vote, the committee defeated the proposal to change the policy so that the new objective would have been simply “to enhance” the pension fund’s private equity returns.

And this part is also important:

At the meeting, Wylie Tollette, CalPERS chief operating investment officer, told the committee that the change was part of the staff’s effort “to eliminate vague and untestable language from all the investment policies.”….

On Monday, Andrew Junkin of Wilshire Consulting told the committee that it doesn’t make sense to lower the benchmark to less then 3% over the stock index.

“At that point I don’t think private equity is worth it,” Junkin said.

In other words, despite CalPERS’ efforts to depict foundational concepts of finance like being paid more to assume more risk from its strategy document as “vague and untestable,” one of CalPERS’ key consultants spoke up against the underlying premise. Andrew Junkin’s remarks at the meeting were even stronger than the Los Angeles Times extract.

Recall that we’ve documented that one of CalPERS’ other major consultants, Pension Consulting Alliance, has been pushing the idea at CAlPERS and CalSTRS of the indefensible idea of an “absolute return” which is tantamount to “no benchmark” and that the CalPERS chief investment officer Ted Eliopoulos has worked similar language into some of his overviews of private equity. So Junkin is to be commended for putting the kibosh on this effort.

Not that CalPERS is giving up, mind, you. The Los Angeles Times says the giant pension fund “still planned to consider revising the benchmark next year.”

CalPERS will attempt to make a rebuttal in the SacBee later this week. This ought to be entertaining. They have yet to learn the wisdom of the saying, “When you are in a hole, quit digging.

Most important, thanks to readers for all your interest and support and most of all, for those of you who wrote letters and made calls to state officials and media outlets in California, for your efforts. They can and do pay off!


*Weirdly that story, which had Melody Jabobsen as the lead author with Starkman is no longer up at the Los Angeles Times, and the story on the result of the vote, with a different headline, with Jabobsen as the author and Starkman credited at the end as having provided assistance, is now up at the same URL. But you can see plenty of footprints of the older piece. For instance, the Sacramento Sun-Times still has the Calpers is set to change private equity policy headline, and this opening section, followed by a link ot the Los Angeles Times website:

When it comes to its controversial private equity investments, the state’s largest pension fund has struggled to meet the performance goal set out in its written policies. Now the California Public Employees’ Retirement System has proposed stripping its policy of that specific return objective – which had been defined as earning 3% more than the broader stock market to compensate for the risk of investing in the private firms.

My recollection of the original story is the Los Angeles Times had obtained a quote from a CalPERS spokesperson, so they were on notice.

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  1. Clive

    Some victories may seem like a lot of hard work for the gains made (I’d bet my morning coffee that CalPERS is, right now, figuring out how it can bring back its benchmarking get-out-of-jail-free card in another guise “once all the fuss has died down a bit”) but every so often you get a sense of the stars aligning and something a little special happening.

    What struck me about this triumph was that there was a willing audience in the mainstream media who was, while perhaps slow to be convinced, nevertheless picked up and ran with the story. So often, all officialdom or government or business needs to do is trot out the same familiar lines of “this is the market at work so don’t you worry your pretty little heads about it, it’s an immutable law, like gravity” or “it’s all much to complicated for you un-enlightened and uninitiated proletariat sorts to understand” and, fearing being wrong or being made to look stupid, that’s where it ends.

    But not this time.

    Of course, if I say “the mainstream media” that does a disservice to the people who (in this case) live in California. The Sacramento Bee — and Bloomberg too, to its credit — have to respond to shifts in their readership’s prevailing mentality. If their readers are no longer willing to accept boilerplate nonsense going unchallenged “we spoke to X about that, they told us it was the market / the industry standard / what our consultants told us / the-dog-ate-our-benchmarks / etc. so that’s the way it is” without thinking to themselves “hey, even I know that’s lame and I can ask tougher questions than that” then those media outlets loose credibility. There is a lot of choice about where we get our information nowadays, if we want serious analysis and investigation rather than entertainment then we’ll only buy the outputs of the news outlets which actually deliver that.

    So that sounds like progress, of a sort, to me.

    1. Yves Smith Post author

      Thanks for your as-usual thoughtful remark.

      One issue I did not belabor here because the post was getting sorta long was that the Monday vote really would have been a point of no return as far as CalPERS was concerned, and that was a much bigger deal than you would imagine given the seemingly technical nature of the proposal.

      Re point of no return. Once the policy language was agree upon, then CalPERS staff would propose the de facto benchmark elimination (“absolute return” or just comparing it v. other asset classes as if they were pretty much the same, or just expecting it to beat CalPERS overall portfolio returns, all options they’ve hinted at). The board would be told that they were just implementing the policy they’d already agreed to. They’d thus have been told that to disagree with the benchmark change, they’d need to go back and undo the policy vote. No way would they do that.

      Re the substance of the change. As we’d indicated, the consultant PCA was arguing the sort of benchmark CalPERS was using (which per Wilshire is pretty much universally accepted as directionally correct) was wrong and was pushing for “absolute returns,” and even more explicitly so at CalSTRS. Sadly, the way fiduciary duty is interpreted in America, if a board follows what its hired guns tell it to do, it is scot free.

      And with public pension funds all believing they are wedded to PE, if CalPERS and CalSTERS, with PCA providing the Consultant Good Housekeeping Seal of Approval, went to “absolute returns” for PE, it would rapidly become a new standard, at least among Dumb Money. This really had the potential to be a huge stealth win for the PE industry.

      1. tegnost

        “The board would be told that they were just implementing the policy they’d already agreed to.”
        And this pressure would certainly have been applied behind closed doors so as not to waste precious board meeting time time. Echoic thanks to clive for his usual clearly stated insight and congratulations to yves for recognizing and pursuing this topic in time to shine a light on it, you are truly a great person.

      2. Active Listener

        Great job, Yves and everyone else who contributed, on the effort to awaken the sleeping board-member caretakers of CALPERS and, by extension (I hope), other state pension funds.

        Are you aware of any public pension funds that have already eliminated quantifiable risk consideration (such as a 3%-over-stock-index benchmark, or something comparable) as a prerequisite for PE investment? As someone who will probably need her state pension in order to remain housed in the future (my eligibility begins in 2023), I am curious.

  2. participant-observer-observed

    Congratulations to Yves and everyone at NC for proving that detailed, substance-based journalism has a responsive audience! The role of journalism providing a important public (and personal) service is well alive at Naked Capitalism in this era of meta-narrative sound-bites and policy infomercials masquerading as a professional journalism! (Let’s watch who tries to jump on the band wagon now.)

    This work is not only the result of consistent, relentless, detailed evidence-based reporting, it also follows on years of journalists like Yves, Lambert, David Dayen, etc. educating and informing readers of the nuanced dynamics at play in a wide range of financial processes.

    In other words, it is certainly profitable for consultants like Pension Consulting Services and Pension Consulting Alliance to have a meme circulate and prevail among pension fund boards and the public that we are somehow too ignorant to learn the details and therefore need to pay an unproven nanny to think the big thoughts for us regarding our own best interests.

    What an arrogant idea! As if the subterfuge of 2008 and the junk ratings parading and trading as A-ratings and decimation that followed in the wake of that phenomena were a long-vanished memory, difficult and foggy to recall!

    Thanks again to Yves and NC and the other journalists who did not drop the ball in following and reporting on CalPERS! (And thanks also to readers for persistent interest and follow up.)

    NB: As for the LA Times dropping and adding reports, this too is proof of another reason why NC is significant. Even if the story in a report stays the same, if the headline changes, it can alter the way such reports are found in search engines. It may be helpful to tag “California Public Employees’ Retirement System” AND “CalPERS” in report metadata such that one or the other appear in titles, tags, keywords, etc., but such that both ultimately appear. Similarly, it makes sense to tag PCA and PCS where relevant.

  3. MikeNY

    Props to you!

    “Vague and untestable”. So there is no such thing as a liquidity premium, no real benefit to equity portfolio diversification, and people should wait in line to pay 2 and 20 to mimic the S&P.

    Great gig for the PE guys, but what screaming disdain for ‘fiduciary duty’.

    1. Assolonius

      Shame on Wylie for his comments before the board, he knows better but i guess the puppet transformation is complete. He has to make up for his bonehead remarks which sparked this whole PE issue earlier this summer: ” we dont know how much we’re paying in carried interest or total PE fees” You might not, but a local consultant youve had on the books for years but which was terminated so you could “reduce fees and complexities” sure does and has told you that number for years

      Last time i checked sharpe, calmar, semi deviation, information ratios are neither vague nor untestable, but Pers investment beliefs sure are!

  4. Sluggeaux

    I’m gob-smacked that the Board stood up to staff on this. Tollette, DesRochers, and Eliolopolous were trying to “pull a fast one” but their mendacity in claiming that “there are no immediate changes being proposed” became incontrovertible evidence of their blatant bad faith.

    As a CalPERS member soon to become a beneficiary, I am grateful to Yves Smith and Naked Capitalism for rousing the news media and breathing life back into the First Amendment.

  5. Steve in Dallas

    Wow, so glad I continued to read Yves’ series of articles. Must say, for me, being a lowly engineer and not of the financial world:

    1) this whole expert investigative reporting process was a fantastic example of competent/good people publicly/collectively pushing back against ignorant/bad/(my opinion… corrupt) people (which we clearly/desperately need MUCH more of), and

    2) much should be credited to Yves’ fantastic writing style (every article gave me a “wow… that-was-good… so-glad-I-read-it… I’m-following-her” reaction… should/could say much more about why I love Yves style/leadership… but I’ll just say… thank you Yves!!!).

  6. TimH

    re “*Weirdly that story…”

    Always (previous word in italics and bold, but not caps because that would be pushy) take a snapshot of key stuff! In my Lubuntu, PrtScn saves a screen snapshot, which is more reliable than Windows which dumps it to clipboard and then you have to do something with it immediately.

  7. Jim Haygood

    ‘… it doesn’t make sense to lower the benchmark to less then 3% over the stock index. “At that point I don’t think private equity is worth it,” Junkin said.’

    Stop making sense! ;-)

  8. Lambert Strether

    Pretty amazing reversal of form by these guys! It will be interesting to see what the staff and those captured try next, but I think the universal framing will now be “what they’re trying next.” That’s an easy story to write, and an easy story to understand.

    I hope things were grim at the office on Tuesday morning, at least in the suites of the executive staff. It would be nice if they found a way to pin the blame for the debacle on Klausner — for good reason, or no reason at all — and threw him under the bus, but that’s probably way too optimistic.

    So, triumph happy dance!

  9. Paul Tioxon

    Good Work!!!
    Hope is what keeps anxiety out of our central nervous system when we having little more than uncertainty to guide us. And working towards a goal of expanding consciousness about private equity risk in public pension funds and skulduggery to cover this kind of thing up is not something you expect to be rewarded with an victory. There is much need to pick a area of inquiry that needs the light of day shed on it so that much needed reform or regulation can step in to set things right. I’m glad you have found a focus and reported with tenacity and that your efforts made a difference that did not take forever to happen.

    Again, good job and hopefully many more dark corners of financial chicanery will bathe in the sunlight of your analytic skills. Many other states are questioning or changing high fee pension fund management to something less pricey but still practical. This story just helps bolster nervous elected officials who stick their necks out, even when it’s the right thing to do, have a valid source of credibility on their side when justifying decisions on the grounds of fiscal responsibility.

  10. ekstase

    As a non-economist, I feel a certain amazement at the sheer audacity of these folks. And as I read through your articles, that’s one of the biggest take-aways. Maybe this will inspire others to see their emperors’ new clothes more clearly, whatever their emperors’ professions may be. Thanks for writing these pieces.

  11. Energeticfourthestate

    There were two places where policy documents sought risk adjusted returns …the PE policy and the benchmarks policy documents. CalPERS seem to be tweeting that the benchmarks policy is retained so no fuss?

    Are you still convinced that ‘eliminating the (PE) policy language that returns be risk adjusted today’ which is still on the cards, is a precursor to axing the risk-adjusted benchmark in 2016?

    1. Yves Smith Post author

      I don’t think you read our posts. CalPERS stated was considering a benchmark change in pionline in December 2014 that was tantamount to getting rid of seeking a risk premium for PE. CalPERS staff and its consultant PCA have made statements in board videos (and we have the clips and the transcripts in our posts) saying they thought the current benchmarks were flawed and PE should be measured on an “absolute return” basis. That means no risk premium. In their PE workshop last month, they showed lots of performance comparisons….of PE versus other CalPERS investments, again either eliminating any risk adjustment OR cooking the volatility numbers (as we explained at length) to make PE look less risky that it was. We posted the actual red-marked document by CalPERS showing exactly where they proposed to eliminate the language about seeking to achieve the maximum risk-adjusted return for PE, and instead seeking merely to have it contribute to “equity” returns.

      Bloomberg ran an op ed by me last Thursday AM where I stated the proposed policy risk language change indicated CalPERS was going to change its benchmark to eliminate the PE risk premium later. CalPERS did not demand a correction. It did not say a peep to Bloomberg. CalPERS hates my guts. They would love to have forced Bloomberg to make a correction, since it would hurt my credibility. The fact that they did not try meant they had no credible argument against my depiction of their plan.

      As I stated in this post, CalPERS pushed hard to get the SacBee not to run the Applebuam/Batt op-ed. They tried the argument they are now flogging on Twitter, that they were just making a change in the policy and that did not imply a change (later) in the benchmarks. The SacBee editors didn’t buy it.

      They put out that tweet AFTER the Appelbaum/Batt op-ed forced CalPERS staff to back down with the board so they would not lose too much face when the board voted down the proposed language change. As we indicated, the policy language change was intended to set up a benchmark change. CalPERS has made repeated statements as to how it would like to change the benchmark, as has its consultant PCA. But you had to be paying attention to catch them.

      You also seem to have missed that CalPERS LOST THE VOTE. The board nixed eliminating the risk-adjustment language. And with the other consultant, Wilshire (which has a must bigger reputation in the wider world than PCA) saying on the record that PE is not worth it unless you get a 300 basis point premium over stocks, and they would not recommend reducing the premium, Wilshire has kiboshed the staff and PCA plan to get rid of the language that required CalPERS to seek a risk premium for PE.

      So CalPERS tying to pretend that because they lost the vote, they never really wanted the change after all. That is how eager they are to try to downplay this story. And it looks like you seem inclined to believe what they say on Twitter. I suggest you exercise a lot more skepticism regarding their PR.

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