Incoming Board Member Margaret Brown Criticizes CalPERS’ Plan to Hurt Beneficiaries by Hiring Unnecessary, High-Priced Private Equity Middlemen; CalPERS Violates Open Meeting Rules by Advancing Plan in Secret

In a bit of synchronicity, Pensions & Investments published a story based on an interview with incoming CalPERS board member Margaret Brown in which she discussed the glaringly obvious reasons why CalPERS’ plans to hire high-priced private equity middlemen like Blackrock is a bad idea.

I was planning to write on the dodgy “outsource private equity” scheme today for a different reason: I’ve been very tardy in writing up two important stories by Sam Sutton of PE Hub. As we’ll discuss below Sutton reported on how CalPERS has been moving these plans forward out of public view. Not only is this at odds with how CalPERS staff said it intended to proceed at an offsite last July, when they first broached the idea. Advancing this program in private is a violation of California’s Bagley-Keene Open Meeting Act. CalPERS isn’t entitled to shield hot topics from the public just because it feels like it. And the fact that CalPERS is unwilling to have proper public disclosure and decision-making on a plan that flies in the face of industry trends and will hurt beneficiaries by increasing costs, confirms that the staff and board know they can’t defend what they are up to.

Background: Why Hiring Pricey Private Equity Middlemen is an Indefensible Idea

If you are up to speed on this issue, skip down to the next bold heading. But this is important background if you are new to this topic or have only a dim recollection of our earlier posts.

CalPERS first introduced the astonishing idea of outsourcing its private equity program to middlemen at a board offsite last July. The presentation included a discussion with experts, all of whom either are in the private equity industry or have financial disincentives to rock the boat; there was no independent viewpoint.

In yet another example of the culture of casual lying that has become institutionalized at CalPERS, staff falsely depicted CalPERS as considering a range of options, including building up an in-house team and doing more co-investments, and said they would come back to the board to brief them with more developed ideas. Instead, as the Sutton articles we will discuss later reveal, rather than look at all options further, staff has moved as quickly as possible with the scheme of outsourcing private equity, and even worse, potentially on a very large scale, when the staff gave the impression in July that even if they went the outsourcing route, only a relatively small portion of the portfolio was up for grabs.

A particularly ugly bit is that CalPERS staff presented BlackRock’s Mark Wiseman as an independent expert in July. Less than two months later, Bloomberg reported that CalPERS was negotiating with BlackRock to outsource some or all of its private equity business. This was totally improper on multiple levels: failure to hold further discussions in public (as board member JJ Jelincic has pointed out, this matter is not entitled to state secret treatment, since it is neither an investment nor a personnel matter), failure to appraise and get approval from the board, failure to go through a request for proposal process. This is so corrupt-looking one has to wonder what the real motivations are.

CalPERS’ sense of entitlement to move forward without board involvement was so strong that when CEO Marcie Frost contacted me in early September just before the Bloomberg story broke to propose an in-person meeting (which I initially accepted but later fell apart due to my insisting any conversation be on the record). When we settled on New York in late September, she mentioned wanting to schedule meetings with BlackRock and Wilshire around the time she would see me. She would not have made that comment if she thought the meetings were controversial, when she should have recognized it as such. BlackRock is not currently a consultant to CalPERS. It is hard to imagine any reason for someone at Frost’s level to have wanted to meet with BlackRock save to advance the private equity scheme.

Caught out by Bloomberg, CalPERS then included a “Follow Up on Private Equity Business Models” as a closed session item, meaning secret from the public, to cover its tracks with the board. Again, there is no legal justification whatsoever to hold discussions of strategy or possible outsourcing in private. As JJ Jelincic said at the time, “I have read the agenda item and can see no reason that it’s in closed session except to save staff from embarrassment.”

We’ve covered the glaring problems with this outsourcing plan in previous posts, such as CalPERS Board Uncomfortable With Staff’s “Fire, Aim, Ready” Plan to Create Unaccountable Private Equity Vehicle; here is a recap from September:

We described at length in an earlier post what a bad idea this is. It is made even worse by the fact that it is a bait and switch. It is inconsistent with the “business models” that CalPERS presented to the board at an offsite in July. As we wrote:

CalPERS will pay more in fees with BlackRock and there is no reason to expect improved performance. As the former Chief Investment Officer for North Carolina, Andrew Silton, stressed, CalPERS is such a large investor in private equity that is unlikely to achieve better than index-like returns. And it’s a no-brainer that introducing another intermediary means more fees and costs.

BlackRock would effectively be a dedicated fund of funds manager for CalPERS, an approach that is typically used only by small fry, like high net worth individuals and and smaller institutional investors, or for bigger players, to achieve adequate diversification for small, niche-y strategies (say if CalPERS decided to make an allocation to infrastructure in Latin America).

It is remarkable to see CalPERS consider outsourcing, since going in the direction of increasing its cost flies in the face of prudent investment management. It also contradicts the approach CalPERS takes in all other strategies in which it invests, where it has a strong focus on expense reduction and manages many of its investments in house because it is cheaper.

Private equity expert and board candidate Mike Flaherman estimated that even if CalPERS negotiated “heroically” that it would pay an additional .20% in fees plus a share of the profits. That means $50 million at a bare minimum versus the roughly $5 million of cost for CalPERS’ current internal team. Moreover:

…it is likely that BlackRock’s compensation will rise over time, as CalPERS will likely pay a much lower fee for BlackRock to monitor legacy investments made by the CalPERS team compared to the compensation paid for new investments sourced by BlackRock. Over time, the CalPERS-sourced investments will be harvested and replaced by BlackRock-sourced ones, likely leading to large cost increases.

To add insult to injury, CalPERS staff failed to tell the board that Mark Wiseman of BlackRock, who staff presented as an independent expert at the July offsite, was very much an interested party.

Even if you were to accept the premise that this outsourcing scheme is a good idea, it is also remarkable to see CalPERS considering only one vendor for it, when many firms would likely be interested in managing the program, and on top of that, a firm that has treated CalPERS badly in the past. The Stuy Town deal was controversial internally when it was under consideration, and there were multiple parties who argued that it was a bad deal .Some people directly involved say that BlackRock had made misleading representations in marketing the deal and also treated CalPERS unfairly as it unravelled. Unless BlackRock has somehow made up to CalPERS for the loss, which seems impossible given its magnitude, it is hard to fathom why CalPERS would be willing to do business with an organization that has dealt with them in bad faith in the past.

Brown’s Criticism of the CalPERS Scheme in Pensions & Investments

It’s a good sign that the press is keen to talk to Margaret Brown. Randy Diamond’s story, New CalPERS board member leery of private equity takeover, recapped three points Brown made in her chat:

“We don’t need another layer of fees,” said Margaret Brown in a phone interview on the potential hiring of BlackRock….

Ms. Brown also questioned the propriety of BlackRock’s head of global active equity, Mark Wiseman, participating in a public discussion at a July retreat meeting on the future of the system’s private equity program…

At the time Mr. Wiseman was making public comments, Ms. Brown said she wanted to know whether the negotiations between CalPERS and BlackRock were already underway. Mr. Wiseman did not comment specifically about a relationship between CalPERS and BlackRock at the meeting, centering his remarks on the direct investment private equity model and pitfalls CalPERS might encounter if it tried that direction.

“We need transparency here,” said Ms. Brown…

She also said that she is concerned that CalPERS has not filled the vacancy of Real Desrochers, managing investment director of private equity at the pension system, who left in April…

Ms. Brown said leaving the position open can enhance the case to turn over the program to BlackRock because CalPERS can claim it does not have a leader of the program and needs outside help.

CalPERS made a non-substantive comment and BlackRock declined to comment.

CalPERS Has Been Moving Forward in Secret….Which It Wouldn’t Be Doing if This Scheme Were Good for Beneficiaries

Sam Sutton published two important articles giving more details on how CalPERS has been working to advance this scheme secretly. In an October 18 article, CalPERS weighs bringing in UC Regents in creation of separate PE entity:

California Public Employees’ Retirement System is considering partnering with other institutions like UC Board of Regents in its construction of separate entities to invest in private equity, a
document obtained by Buyouts shows.

The document, from the closed session of its Sept. 18 board meeting, sketches a number of ideas for creating separate PE investment entities. Among those are “partnerships with others like UC Regents,” according to the document.

Again, there’s no justification for keeping beneficiaries and California taxpayers in the dark, particularly when CalPERS plans to or actually has put out feelers to third parties like UC Regents.

In mid November, PE Hub published CalPERS hopes to have  finalists for independent PE platform by early 2018. From Sutton’s story:

California Public Employees’ Retirement System is moving forward with plans to bring on an outside firm to manage its $25.9 billion private equity program, internal documents obtained by Buyouts show..

CalPERS sta􀃗 plans to introduce the two best candidates to manage the platform to CalPERS’s investment committee in the frst quarter. The goal is to launch the new partnership “as close to the new fiscal year (July 1, 2018) as possible,” the staff presentation says…

CalPERS’s criteria for a potential outside manager includes an ability to commit “a material amount of their own capital alongside the investments they select for CalPERS,” the sta􀃗 presentation says. The 􀃒rm would also have to act as a 􀃒duciary and “champion” of the system’s guidelines on environmental, social and governance issues, as well as sustainability.

Notice how utterly dishonest this is. Contrary to the clear requirements of California’s Bagley Keene Open Meeting Act, the public has been denied the opportunity to review and provide input on this program to enrich the private equity industrial complex further at the expense of CalPERS’ beneficiaries.

Not only will the costs for this program unquestionably be higher, there is no reason to expect any improved performance. CalPERS is so large that the best it can expect to be is de facto indexer.

Moreover, CalPERS is certain to be unable to get real “talent” to manage this program, save by taking the time to build an in-house team (Ludovic Phalippou of Oxford says he has qualified former students who would make very good hires for CalPERS, so the idea that CalPERS would not be able to build an internal effort is a myth the current leadership seems desperate to propagate). The false deadline of the next fiscal year looks like a deliberate effort to rule out courses of action that have vastly more upside for CalPERS but would make current management work, something they appear loath to do.

Top tier players like KKR and Silver Lake would not accept, say, a Carlyle managing their funds. The fact that CalPERS is relying on the advice of conflicted consultant Hamilton Lane, whose fund level due diligence consists mainly of cutting and pasting general partner documents, illustrates what a garbage-in, garbage out exercise this is.

Finally, this sorry discussion leaves us with only one reason that CalPERS is moving forward with this dreadful idea: it finds it more expedient to engage in more and more cover-ups, via shielding private equity from scrutiny, rather than grapple with the drivers of its poor performance. That would include first and foremost, addressing the fact that the current Chief Investment Officer Ted Eliopoulos isn’t capable of doing the job. This proposed program is thus a hugely costly effort to cover for his shortcomings by dumping the highest-risk but also highest-upside-potential investment on outside parties.

Readers need to rally behind Brown’s efforts to demand that CalPERS do better. Let’s hope for the sake of CalPERS’ beneficiaries and California taxpayers that she makes real headway.

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15 comments

  1. Larry

    Great coverage Yves. Let’s hope the new board member can start to overturn some of these egregious violations and bad practices.

  2. lyman alpha blob

    What I don’t understand is what’s in it for the CalPers people. If they sincerely thought this was the best way to go for public employees, why the secrecy? Are they all just credulous and just believe this is the way things ought to be done? Neither of those two make much sense to me, which leads me to believe there’s likely to be some mutual back-scratching going on somewhere. Why facilitate BlackRock making a fortune if there’s nothing in it for them?

    1. sd

      Mediocrity. If someone is not very good at their job, and doesn’t really want to do any work, they mask it by behaving like bullies and bringing in so-called experts. They still get the salary but none of the responsibility or risk.

      We are living in the age of mediocrity.

      1. RUKidding

        Maybe. I don’t dispute your contention about mediocrity, but really? IMO, I think it goes beyond mere mediocrity and/or just not being very good at your job.

    2. John Zelnicker

      @lyman alpha bob, 12-14-17, 8:47 am – Something is in it for someone(s). Yves has carefully shredded any and all justifications for this project leaving only bribery and corruption as the real answers, IMNSHO. The only questions are who and how they are being bribed, whether they’re getting cash and/or benefits now or promises of the same in the future.

      1. RUKidding

        You echo how I feel. Someone(s) are benefiting from this in some way, otherwise, why all the secrecy? And Yves, and others, have written up enough about this – it’s now public knowledge – that there should be some accountability for these actions. Yet we get nothing but ever more obfuscation and more secrecy.

        I’ve said all along: Cui bono? It’s certainly not ME as a current CalPers contributer and future CalPers annuitant. I’ve always suspected that backs are being scratched. We just don’t have absolute proof of that.

        Hopefully Margaret Brown can help shed some light on this. Good luck to her, as she’s going to need it.

        1. TheCatSaid

          Perhaps some whistleblowers will let Margaret Brown know if palm-greasing is underway in one form or another. The revolving door could be a part of the picture for some Board members or staff. There may be a number of “incentives” at play, depending on the vulnerabilities of the person whose cooperation is sought.

          The CalPERS Board and senior staff decision-making processes smell and look so bad that epic corruption could be afoot. Some of it may be “under the cover of law” as George Webb would say. Whatever is going on, transparency and accountability are key if there is to be meaningful improvement.

          1. Adam Eran

            I’d personally doubt explicit bribery is the culprit here. The promise of lucrative employment after having served on the board is enough to sway most of the revolving door crowd.

            Coincidentally, I just recently discovered that former Folsom mayor and city council person Bob Holderness is now working for Angelo Tsakopoulos–a politically powerful land speculator in California’s central valley. In his public positions, Holderness was supposedly the impartial regulator of developers like Tsakopoulos. He’s now shilling for a proposed outlying development that Angelo wants. Naturally Angelo got what he wanted from Holderness before he retired from “public” service.

            I’m old enough to remember that Harry Truman turned down all those corporate board jobs after he retired. Those were the days, eh? (And Truman gets some significant criticism from the Real News for his policies.)

            Ah California! You can practically smell the corruption!

  3. EoH

    Few pension funds anywhere have the size or resources of California’s. Why would it outsource basic or even advanced funds management to other profit-taking contractors when it could as well and more cheaply manage such things itself?

    The mostly likely answer seems to be a confluence of ignorance and control. External advisers provide de facto insurance policies. A somnolent board would give employees a free pass for any problems, ineffectually blaming the outside managers. That is, imposing no sanctions, such as – gasp – taking business elsewhere when outside managers screw up badly or consistently. That seems as unthinkable as changing outside auditors.

    The approach also mirrors what appears to be the standard neoliberal business model: outsource everything, be responsible for little, collect big paychecks as intermediaries. That absolves the plethora of middle and senior managers of actually knowing about the business they’re running, which allows anyone from any background to claim they can do it. (See, GM bankruptcy, university and college “assistants” and “vice presidents”.) The resulting lack of control, resilience and real – instead of “financial” – performance are redefined as features, not bugs.

    The result is many millions of wasted resources Calfornians, as relatively well to do as they are, can little afford.

  4. EoH

    In addition to institutionalizing the staff’s role as know-little and responsible-for-less, but highly paid intermediaries, the direction the staff are taking represents a privatizing of the commons. Here, it is privatizing high administrative fees and profits paid to private equity, while keeping the cost of those and the cost of historically weak performance, certainly not performance commensurate with the risk and fees – and the opacity.

    To add insult to taxpayer injury, there would predictably be no risk to the poor performer, no evaluation that could or should result in private equity’s loss of business. Given the merits and the lower cost and greater resilience of doing this in-house, I would say the staff have gone beyond gross negligence to intentional misconduct. It will cost, as you say, tens to hundreds of millions of taxpayer dollars. A thorough change in staffing seems in order.

    This appears to be garden variety neoliberalism, a kind of Norquistian refusal to let government do what it can do well and better than the private sector for fear of permitting an infectious disease agent to proliferate.

  5. flora

    There’s a lot in this post. Focusing only on two of the issues raised:

    ‘ “We don’t need another layer of fees,” said Margaret Brown….’

    I think Ms. Brown is more up to speed on the CalPERS investment problems than the rest of the board. Sounds like she has ‘hit the ground running’, as the saying goes, which is terrific!

    and

    ” California Public Employees’ Retirement system is considering partnering with other institutions like UC Board of Regents in its construction of separate entities to invest in private equity,….”

    UCBoR has a $100 billion endowment fund they invest using inhouse expertise (I believe). So some questions about this CalPERS move: Is CalPERS using the UCBoR as a feigned possibility to make a Black Rock deal look less like an insider secret handshake ?, or is CalPERS trying to sucker money out of UCBoR to invest in Black Rock? I’m sure there are other possible explanations, but at this point my trust in the CalPERS board’s good faith and general investing intelligence is nil.

    Thanks very much for NC’s continued reporting on CalPERS, pensions, and PE.

  6. Synoia

    I’m absolutely positive there is no notion of any form of “kickback” to any of the Calpers senior management from the PE firms.

    This is just a misunderstand of the complexity of the Capers senior jobs, and they are truing to get the best returns for their retirees, and the Calpers Board and Management have the retirees best interests as their only motivation whatsoever.

    The Calpers Board and Senior Management’s efforts bear no trace at all of being able to blame others for bad performance of their funds.

    1. Yves Smith Post author

      It is outrageous to say that CalPERS is not responsible for the performance of its investments. What about being a fiduciary don’t you understand?

      You need to get up to speed. CalPERS is responsible. The Wisconsin state and San Francisco pension funds are fully funded. CalPERS has long been the pension fund with the biggest budget, in terms of staffing and ability to hire advisors. It has no excuse for not translating this into better decisions.

      CalPERS lost more in the crisis than most public pension funds by virtue of having a higher risk exposure than most, such as not lightening up on real estate, even when one of its senior portfolio managers was urging to do just that (CalPERS apparently didn’t want to lose out on a relative basis), by engaging in securities lending and getting caught out (as AIG was, AIG lost almost as much from that as from its bad CDOs), It suffered a liquidity crisis due to private equity margin calls and had to dump stocks at pretty close to crisis bottom to come up with the necessary funds.

      CalPERS staff and board are also responsible for decisions that have led to lagging performance even relative to other public pension funds by deciding a few years back to cut its number of private equity funds, which would have the effect of having CalPERS invest only in moderately to very big PE funds. Its PE consultant just said that decision hurt performance.

      CalPERS staff in the last 4+ years has also lagged in its public stock portfolio, by having a ~50% exposure to foreign stocks, way more than needed to achieve diversification. They were placing a bet that the dollar would weaken when it has instead remained strong.

      Chief Investment Officer Ted Elioupoulos also made a market timing bet and cut equity related exposures before Trump took office. Ooops

      More specifically, with regards to private equity:

      1. You ignore the corrupting influence of cognitive capture, which operates at vastly more powerful institutions, such as the Fed

      2. Staff at public pension funds believe private equity firms can get them fired. There is no evidence that this has even happened, and in fact it would look like punching down were anyone to try that. But I am told by former industry consultants that that belief is widely held.

      3. Staff at public pension funds also apparently believe that if/when they wanted to leave, private equity funds could help them get a job by putting in a good word for them. Again, I find it highly unlikely that this would ever happen. Insiders both agree the odds of a PE firm providing any meaningful help are pretty much zero, yet also confirm that many public pension fund staffers appear to believe private equity managers can and do help. That alone is a corrupting influence.

      4. There is widespread soft corruption. Private equity firms hold annual meetings for their limited partners in posh locations, with fine food, pricey wine, and often, top drawer entertainment (we wrote about how one fund hired John Elton to perform). These expenditures are all on the beneficiaries’ dime. They are charged back to the fund.

      The limited partners kid themselves that they get important intelligence out of these highly scripted meetings, like how cohesive the management team is. If you believe that, I have a bridge I’d like to sell you.

      In addition, staff at CalPERS are engaged in further busywork by participating in advisory committee meetings. As we have written repeatedly, the advisory committees are designed to be toothless, The general partners make sure they have more than enough limited partners who are assured to back them in the event of a controversy so that serving on an advisory committee does nothing to improve fund governance.

      If staff at CalPERS wanted to do their job, they’d be vastly better informed if they eschewed theses meetings, which along with new fund due diligence chew up most of their time, and read the documents the general partners put out about their funds, in particular, their SEC Form ADVs, which appear to be just about never reviewed in a meaningful way by limited partners.

      You act as if CalPERS is some sort of passive victim. It isn’t. CalPERS is way behind on industry developments that improve performance by cutting fees, namely co-investing. Moreover, a firm with CalPERS’ resources would be well positioned to bring more private equity investing in house and reduce fees. Did you miss that we’ve written repeatedly that CalPERS has confirmed Oxford professor Ludovic Phallipou’s estimate that CalPERS pays 7% per annum in private equity fees and costs? If it were to bring PE in house, it would cut that down to at least 3%, probably more like under 2%. 400 to 500 basis points in savings would make a huge difference in potential returns. And we haven’t bothered mapping out possible ways for CalPERS to go about doing this because the fund is so clearly not receptive, but this is an entirely realistic goal, particularly since some Canadian public pension funds have already moved great chunks of their private investing in house, demonstrating this can be done.

      And if CalPERS were to get serious about doing more direct investing, it would also encourage more funds to go the same route and act as a check on the egregious fee level.

  7. Sluggeaux

    CalPERS is being looted, plain and simple.

    There is no cop on the beat. Clintonite Attorney General Xavier Becerra will continue Clintonite ex-AG Senator Kamala Harris’s hands-off policies towards Bagley-Keene violations and corruption at the fund (it was the Feds from the Republican-leaning U.S. DOJ who imprisoned CEO Buenrostro). You’d better believe that these Clintonite hacks are the direct beneficiaries of political contributions from BlackRock and its employees, both directly and laundered through lobbyist “placement fees” and other artifices.

    The AG now claims that the State Auditor must administer Bagley-Keene, because there’s a “conflict” with their “representation” of state officials (a brand-new legal contrivance completely alien in the history of state AG’s). However, State Auditor Elaine Howle (BA from UMass in Sports Management!) has spent her 16-year sinecure as a Sacramento hack with ZERO enforcement authority and had her latest re-appointment held up by staff whistleblowers. The staff at the State Auditor have told me that the only way that Bagley-Keene will ever be enforced is via a private lawsuit — and then they begged me to file such a suit, since they are CalPERS members themselves! As a beneficiary, I lack the resources — but it looks as if since the Retired Public Employees Association (RPEA) intervened in the Board election that they may finally be smelling the rot.

    I think that it’s a fascinating bit of foreshadowing that Adam Ashton’s SacBee article on Brown’s upset ends by repeating the canard against Margaret Brown about “hostile workplace claims” which are part of the territory in her job and were never sustained. This is exactly where CalPERS staff went against JJ Jelincic when he broached the slightest criticism of the abysmal job performance of the staff — they got the hacks on the Board to sanction JJ for creating a “hostile work environment” (Ted Eliopoulos #MeToo).

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