Dan Primack, who has long been one of the most influential commentators on the business of private equity, weighed in yesterday on CalPERS sketchy plans to create new vehicles with supposed whiz-bang new strategies to run its private equity program. We discussed at some length how Chief Investment Officer Ted Eliopoulos told five Big Lies in his effort to hoodwink CalPERS beneficiaries and the board about what this scheme really amounted to.
Primack cut to the chase in his Axios piece, CalPERS sets questionable private equity course:
There are only three things in life you can count on: Death, taxes and CalPERS doing strange stuff with private equity….
Over the years, CalPERS management has treated its private equity strategy like a toddler treats a Netflix queue. Let’s try this. No, let’s try that. I don’t even know what that is, but it sure looks cool….
The mastermind here is CalPERS chief investment officer Ted Eliopoulos, who resigned just in time to not oversee its execution.
If that’s not a big enough red flag, here are more:
- The comp is supposed to be Canada’s big public pensions… But those Canadian systems generally maintain oversight rather than creating independent boards. Or, put more simply: CalPERS is creating an indirect model for direct investing, which seems to largely defeat the point.
- If a goal is to lower fees, it might be tough given that CalPERS Direct will pay “market rates” to its investment professionals…
- If a goal is to put more money to work, this could be easily accomplished by reigniting commitments to third-party funds — something CalPERS used to do tons of but then slowed way down in the name of negotiating better deals and simplifying the portfolio….
- If the goal is to increase transparency, then why create a separate governance structure?
- Late-stage and Buffett-style strategies are the two hottest trends right now in private equity, which likely means it’s a questionable time to launch new programs that won’t be ready until the first half of 2019. In fact, CalPERS has a distressing private equity history of diving in near market tops and exiting near market bottoms (see: Capital, Venture)….
Bottom line: It’s certainly possible that CalPERS Direct will improve returns. But stronger odds are that it won’t, and that CalPERS will again shift strategy before any of us — or its 1.9 million members — know the ultimate results of what is supposed to be a long-term play.
Notice that Primack echoes some of the points we’ve made:
CalPERS’ assembled gimmicks are indirect, not direct investing
The idea that CalPERS’ can’t put enough money to work through existing managers (which is what Eliopoulos insisted last week) is ludicrous1
The two “new” ideas that CalPERS announced with great fanfare last week are unlikely to produce returns at the level of current private equity investments
To be honest, I hadn’t taken either “holding stakes in venture capital companies that refuse to go public” and private equity general partners pushing for funds that were designed to have longer lives than anything other than new ways to profit from situations not of their making. Late stage VC is a gimmick to get dumb money in so as to help prop up valuation. It is not badge of honor that CalPERS seeking to step into a role that has heretofore been taken up by chumps like the Saudis and high net worth individuals who like the bragging rights of owning a piece of a famous tech company that is exclusive by virtue of being private.
Similarly, the push for longer-lived funds looks like a response to expected lower returns in the future. For the last two years, the heads of top private equity players have been warning that future results will probably fall short. One response has been to push the SEC to allow for retail investment in private equity funds. Another has been to set up new funds with much longer investment time horizons. It isn’t hard to imagine that less money will go to private equity funds in a decade from now, between more and more limited partners doing more direct deals, and the enthusiasm for the approach weakening as returns falter. So one last great fundraising, with the general partners promoting longer-lived funds as a plus for investors, rather than a plus for them, is another way to stave off the changes that sustained lower returns will produce.
A more understated, but if anything more damning indictment came from CalPERS’ private equity consultant, Meketa. From Bloomberg:
While the new strategies offer promise of bigger scale and lower fees, there are also challenges, according to Steven Hartt, principal at Meketa Investment Group, Calpers’s private equity consultant.
“They need to think carefully about how they set up these investment vehicles,” Hartt said. “If the structure’s not right, there could be a misalignment of interests, and ultimately if this doesn’t go well and Calpers decides to move away from it after getting started, there could be some reputational risks as well.”
Recall that CalPERS was trying to make a big PR splash, and this Bloomberg story was one of the first articles to hit the wires. CalPERS consultant is expected to join in the cheerleading, or otherwise say nothing. For Meketa to offer only caution and negative scenarios is tantamount to them publicly distancing themselves from the idea. That’s a huge red flag.
Primack also had an important tidbit in his story. Remember how CalPERS was pursuing the barmy idea of a private equity funds of funds that was certain to cost more and thus lower net returns? How CalPERS was using the indefensible process of soliciting interest with a clearly-not-thought-out request for information that was clearly an exercise in cronyism (only six funds invited to participate, request put out on December 20 and responses due in January 19)? How it was an open secret that CalPERS wanted to give the business to Blackrock?
That does not appear to be working out according to plan. From Primack:
There was talk last fall about CalPERS outsourcing all or part of its private equity program to a firm like BlackRock. A spokesman tells me that such discussions are “not completely off the table, but on a separate track.”
Recall that we’d said this funds of funds scheme appeared to have run into some obstacles, given that CalPERS was supposed to have had its interviews with finalists by April at the latest, yet there hasn’t been enough time blocked out on the board’s agendas for that to have happened.
Weirdly, I’ve heard from multiple contacts, who in turn have heard scuttlebutt back from journalists (and different ones, names have been named, so it is not as if I’m hearing the same source material through different daisy chains) that Blackrock came in vastly higher in price than any other firm. One contact said it was double Goldman’s level. While that may be exaggerated, it is probably not much exaggerated. Needless to say, having the pet vendor come in so far out of line to everyone else seems to have put CalPERS on the back foot. It’s just about impossible to square going with a super high cost bidder and meeting one’s fiduciary duties, particularly since California puts strong emphasis on minimizing investment expenses.2
Given that most reporters on the CalPERS beat are either captured or too time-stressed to do real digging, this level of negative commentary so early on would be hard to ignore if CalPERS really were pursuing its aim of sanity checking its ideas. But this is clearly a sales push, and CalPERS is certain to cherry pick its coverage to justify continuing to pursue hair-brained ideas, at least from the perspective of watching out for beneficiaries’ interest.
1 As we’ve long said, the big reason not to want to work with them is their high fees and that they cheat on top of that, but Eliopoulos said this program was not about reducing fees and costs.
2 I am not sure whether this source was pulling my leg or not, but I was told staff was trying to justify Blackrock’s price by insisting that Goldman would cheat twice as much, so really there was not much of a difference at all.