CalPERS CEO Marcie Frost Describes Her Intent to Leave the CalPERS Board Holding the Bag for Flawed Private Equity Scheme She’s Pushing Them to Approve

CalPERS CEO Marcie Frost continues to push the CalPERS board to adopt a new private equity “business model” despite her inability or refusal to explain in a cogent manner how it would help beneficiaries and the California taxpayers who are ultimately on the hook for pension obligations.

The lack of a rationale for a costly and unprecedented restructuring raises red flags that the only people who will come out ahead are insiders. Indeed, as we explained earlier, there are reasons to believe this scheme will hurt returns due to:

No savings on fees and costs

Lower returns by relying on first time funds

Less diversification

We’ll discuss a speech Frost gave at the semi-annual General Assembly of the Retired Public Employees Association of California in September, which included a big plug for this ill-conceived private equity scheme. Needless to say, the sales talk continues to be content-thin and counter-factual. It’s likely that Frost and her staff are making similar arguments to other “stakeholder groups”. And that explains why they are not willing to pass on CalPERS’ propaganda on this issue, as we described earlier this week. They’re troubled by CalPERS’ failure to come clean on something this radical, and they aren’t willing to front for it until they get answers.

The only benefit that CalPERS has asserted is that this scheme will be “innovative,” which as former Fed chairman Paul Volcker explained, in the finance business produces no economic benefits but merely “moves rents around” meaning away from the people with money to those pushing the “innovations” on them. Warren Buffett, who CalPERS claims it is trying to emulate, made the same point with his story about the Gotrocks family, under the heading How to Minimize Investment Returns in the 2005 Berkshire Hathaway annual report.

But perhaps Frost does have some appreciation of the downside risks of the reckless private equity scheme that she and CalPERS senior staff are still trying to push over the line. As we’ll see, she is taking the position that the board will be responsible if this plan moves forward. While that is generally true, and oddly a point the board doesn’t seem to care much about given how much authority it has delegated to staff, it’s telling that the chief shill for this idea is distancing herself from accountability for it.

Below is a recording of Frost’s talk at the Retired Public Employees Association meeting:

Here is the relevant section, at 19:35:

So I think I should also talk about—I think you may have seen some of the coverage on this. And our board has been getting a number of updates from my team, as well as some offsite speakers, on what we call CalPERS Direct. And CalPERS Direct will be [one?] of the two pillars in what we are calling our new private equity strategy.

The first pillar is going to be our Emerging Manager Program, it’s re-affirming our investment, and our interest, and our belief in the emerging manager program and helping these emerging managers get into larger institutions where, with an early relationship with them, having it continue into a very profitable one in the future. Pillar Two is really around how we co-invest, and this week was an article where CalSTRS announced their own strategy. That strategy is not dissimilar to the one CalPERS will be asking its board to move forward with. They chose a firm called AlpInvest to help them to do their strategy. What I am calling the Pillar Two. And there we are, to give you a different idea. And then Pillars Three and Four. CalPERS Direct is the Innovation. And that’s where we would be invested in what we call late staged venture, and tech and health sciences. You may have seen some of the coverage on this. We really believe that there is a barrier to entry into Silicon Valley for most of the pension systems in California, and that it’s really unfortunate because it is in our own backyard. And so this would allow us the opportunity to get into tech and health science, and not just in Silicon Valley, but certainly, that would be a playground for us. And then CalPERS Direct Horizon is the long-term investments, and this is really around the core economy.

And I guess some of the questions that have come up, and it would be, you know, and I sort of and I would say, some of the concerns, the questions are at least two [kinds?] in particular, is that, it would have a different board and a different governance structure than the CalPERS board. And the CalPERS board needs to pay close attention to that. They have governing authority today over the $360 billion. And if you were to take 10 percent of the portfolio and basically give it to 200 governing bodies–of course we’d need alignment of interest with CalPERS, that would be absolutely required. But you’d have to ask a lot of questions about whether that’s the right decision to make. These are fiduciaries of the fund, and they are ultimately accountable for decisions that happen at CalPERS. So we are not yet ready to take the governing decision back to our board. That likely will happen after the first of the year. And it is imperative that we get a CIO, a new CIO, onboard first to be able to walk through with our board their views on these models.

So we talked about the models. This is the four: emerging managers, co-investment and the partnership model and then the two, what we call CalPERS Direct, Innovation, and Horizon.

Even at a high level, CalPERS isn’t explaining its scheme clearly, which is already a red flag, given that CalPERS has a ginormous PR department that is supposed to be good at that sort of thing. As one prominent retiree who heard Frost put it:

Honestly, I think that if you gave someone an open book quiz, with the text in front of them, about how many pillars there are and what they consist of, I don’t think people generally would be able to answer based on Marcie’s speech.

As we explained earlier in the week, CalPERS plans to increase the size of its existing emerging manger program, something Frost does not make clear. Nor does Frost ‘fess up that CalPERS’ emerging manager program now delivers the worst results of all of its private equity sub-strategies.

Moreover, there’s no reason to think CalPERS can improve on its sorry results. Frost tries to sell the notion that CalPERS will somehow do better by getting in with supposed future winners early in their life. However, there is no reason to think that a manager on his second or third fund who has proven himself, won’t take CalPERS’ money. And there is considerable evidence that “emerging managers” underperform more seasoned ones. From the well-known private equity expert Steven Kaplan, a professor at the University of Chicago’s business school:

As we show later, larger funds tend to outperform smaller ones, potentially inducing an upward bias on the performance of funds for which we have returns. Also, first-time funds do not perform as well as higher sequence number funds.

Here, by “higher sequence number funds,” Kaplan means later funds by the same firm, since they typically number them in sequence (for instance, “Apollo VIII” comes after “Apollo VII”). So “emerging managers” do badly both by virtue of being novices and by running small funds.1

Frost also makes a approving mention of CalSTRS engaging AlpInvest. Does Frost understand that AlpInvest is a wholly owned subsidiary of Carlyle and therefore in no way, shape, or form independent? In addition, Carlyle has a large number of “AlpInvest” entities, which is an indication of its significance to Carlyle. This is another proof of public pension funds not knowing what they don’t know, which is a more polite way of saying that they are marks.

Frost makes a demonstrably bogus claim that there is a “barrier to entry” to California pension funds investing in venture capital. An online search shows the San Francisco public pension fund just made new commitments to three venture capital funds. 23% of LACERS, (Los Angeles City Employees Retirement System) new commitments in 2017 were to venture capital/growth equity. I stopped looking after checking these two and only these two California public pension funds.

CalPERS is trying to greatly overhype the impact of a settlement CalPERS entered into with the Mercury News in a Public Records Act suit in 2002. CalPERS agreed to publish limited data about each of its private equity funds, including the returns, on a quarterly basis. Sequoia Capital and Kleiner Perkins had hissy fits and said they’d never let anyone into their funds who’d expose their returns.

The logical conclusion is that those fund managers have something to hide, and in the case of Sequoia, that certainly appears to be the case. While Sequoia’s flagship fund apparently does deliver attractive results, pretty much no one gets to invest in that alone. They are required to invest in other Sequoia funds, like ones it has in China. The other funds don’t do well so the blended return isn’t very good. But the returns secret allows Sequoia to keep the performance of its doggier funds under wraps.

Nevertheless, the juicy part of Frost’s remarks is near the end of the excerpt, specifically:

….some of the concerns, the questions are at least two [kinds?] in particular, is that, it would have a different board and a different governance structure than the CalPERS board. And the CalPERS board needs to pay close attention to that. They have governing authority today over the $360 billion. And if you were to take 10 percent of the portfolio and basically give it to 200 governing bodies–of course we’d need alignment of interest with CalPERS, that would be absolutely required. But you’d have to ask a lot of questions about whether that’s the right decision to make. These are fiduciaries of the fund, and they are ultimately accountable for decisions that happen at CalPERS.

This is a bizarre combination of handwaving and blame shifting. Frost’s staff has been entirely in charge of the conception and design of this napkin doodle masquerading as a plan. They are the ones who decided on the cute idea of setting up outside entities that CalPERS will not control. And now she takes the line “the board needs to pay close attention to that”? How about seeing if the governance makes any sense before trying to foist this monstrosity on them while pretending everything about it is hunky dory?

If you listen to the tape, even with its not-great sound quality, you’ll hear Frost’s voice sound anxious when she starts on “the board needs to pay close attention.” So why isn’t she giving them the information they need, like budgets and business plans and detailed governance documents, rather than making concerned noises in front of non-decision-makers?

And the ideas that there can be much in the way of “alignment of interest” is spurious. Go read the extract from Buffett’s 2005 annual, starting on p. 17. He makes clear that the use of Helpers, meaning investment “professionals,” reduces investment returns and should be avoided as much as possible. Consistent with Buffett, we’ve urged CalPERS to bring its private equity investing in house, rather than do precisely what Buffett warns against: engage in more motion, which reduces returns.

But here’s the statement that should have every board member sweating bullets: “…they are ultimately accountable for decisions that happen at CalPERS.” Staff has made keeping the board hamstrung one of its top priorities. Worse, the board has so deeply drunk the staff’s Kool Aid that they took the position in a September 26 board meeting, when they refused to approve the travel expense for board member Margaret Brown to observe the supposed count of paper ballots in Everett, Washington (in fact, contrary to CalPERS’ regulation, they were scanned, making a public count impossible), the board trusts staff and doesn’t need to check on any matters they had delegated.

There is one bit of good news in what Frost said: “And it is imperative that we get a CIO, a new CIO, onboard first to be able to walk through with our board their views on these models.”

Let us hope she is as good as her word and allows incoming Chief Investment Officer Ben Meng enough time to give a proper look at what departing CIO Ted Eliopoulos and Frost have been pushing. On the one hand, given the lack of research and apparent lack of budgets or plans, he won’t have much to review. However, any prudent manager would want to make a proper assessment, and that would presumably mean trying to fill in the many blanks heretofore left empty. And that also assumes that Meng is comfortable with the scheme when he takes a hard look at the risks versus the (so far not specified at all) benefits.

Earth to Frost: Innovation is not a benefit. It is at most a means to an end.

The board has apparently been content to let the staff bring them a private equity Rube Goldberg machine and not do any verification. Even the board’s conflicted fiduciary counsel (by virtue of not just representing staff but also having staff direct her work with the board and pay her bills) hasn’t made an appearance since May, which would seem to be a bare minimum step in due diligence. We’ve heard rumors that CalPERS’ private equity consultant Meketa has been kept well away from this scheme.

So having given the board the mushroom treatment throughout, Frost is now trying to shirk her responsibility in this matter by telling the board it’s on the hook for any governance failures, when she’s the one who has been trying to foist this untested new investment machinery them. How this board can possibly trust someone who is willing to dump risk on them while denying them the information and resources needed to make an informed decision is beyond me. The only sensible conclusion is that Frost sees significant personal upside in getting this done and is delighted that someone else will wind up holding the bag.


1 Note that CalPERS’ “emerging manager” program allows CalPERS to invest in the first, second, or third fund launched by a private equity firm (see “Program Parameters“). CalPERS’ disclosure is deficient. Its Private Equity Program Fund Performance Review shows two emerging manager funds run by Grosvenor, GCM Grosvenor DEM, L.P. and GCM Grosvenor DEM II, L.P. with different vintage years, committed capital and returns. Yet if you click on each link, both take you to the same page, for GCM Grosvenor DEM, L.P., which shows 22 funds. One of them is apparently the fourth fund by one of the private equity firm, NovaQuest Pharma Opportunities Fund IV, L.P., which is not consistent with the program requirements, and it has also scored the worst results, a -25.1% IRR. However, you can infer they are all small funds by virtue of the small amount of invested capital in each, which means Kaplan’s other reservation about emerging managers, that small-sized funds generally underperform, also applies.

Print Friendly, PDF & Email


  1. diptherio

    Re: the number of pillars.

    Anybody else reminded of a Monty Python sketch?

    “The two pillars of our strategy are emerging managers, direct investment and partnerships…The THREE pillars of our strategy are emerging managers, direct investment, partnerships and CalPERS Direct…FOUR pillars, the four pillars are…”

    1. The Rev Kev

      If she gets up to seven pillars, then she’ll be encroaching on T. E. Lawrence’s “Seven Pillars of Wisdom”.

    2. Doug Hillman

      Forget about the Bass-o-Matic This innovation uses a 3-HP, 12-blade whole-fruit-husk-and-all molecular liquifier on the English language. It extracts every last atom of meaning and then vaporizes it.

  2. TimH

    Small nitpick per “This is another proof of public pension funds not knowing what they don’t know”… surely “more evidence”, not “another proof”.

    Proof and evidence are not synonyms.

      1. TimH

        Interesting. The article says that common usage and dictionaries have conflated the two, but the other comment, which I paste below, is along my thinking:

        “…’evidence’ and ‘proof’ have unfortunately become conflated in modern usage. I say it is unfortunate because the formal usage actually refers to a related but quite different concept. With a proof (in the formal sense of the word,) if the proof is constructed correctly, it is not possible for the conclusion to be false if the premises on which it is based are true.

        Proofs require either deductive reasoning or exhaustive induction to be used. Evidence, on the other hand, can be interpreted to suggest a conclusion, but doesn’t actually prove that conclusion to be necessarily true. Such a conclusion is reached via inductive reasoning. This seems to be the case with your friend’s assertion.”

  3. flora

    Thanks for this post. I read the Frost quotes carefully. It was revealing. What I read was what I’d call a collection of buzzwords strung together with aspiration words and empathic filler; a talk designed to create the impression Frost knows what she’s talking about (but doesn’t) and cares about the ‘relationship’ of CalPERS to its beneficiaries on an emotive level, but not necessarily on a financial level.

    I’ve worked with a couple of people like this. Their great skill is in picking up the right words with the right authoritative intonation to convince their audience they know what they’re talking about. In reality they too often don’t have a clue – and may not even realize they don’t have a clue. They are wonderful mimics of competence. They can go far …as long as real experts don’t start questioning or looking beyond the surface presentation.

    Thanks for questioning and looking beyond the surface presentation.
    Thanks for your continued reporting on CalPERS, PE, and pensions.

    1. John Zelnicker

      November 1, 2018 at 2:11 pm


      The excerpts of Marcie’s talk (I didn’t listen to it) are nothing but word salad made to appear meaningful by the skills you describe.

      Yves – I join flora in being grateful for your continuing work on this.

      1. Doug Hillman

        Ha! Return my stolen words, Darius, you knave!

        If we learned anything from Obama in politics and human affairs, it’s the supreme importance of sincerity. If you can fake that you’ve got it made.

    2. Another Scott

      Whenever I read something from Frost, I can’t help but think of this scene from the Simpsons

      The more I hear from her, the more it appears that she isn’t knowledgeable on the subject. She keeps using the types of phrases that I see people who in are in over their head use. People who are closer to the subject than me (especially the employees and beneficiaries) must find this excruciating.

  4. Eudora Welty

    I wanted to believe the header was, “Calpers CEO Marcie Frost describes her intent to leave.”

    1. Antagonist Muscles

      I misread the headline the same way. I thought, “Un-bloody-believable! This is some juicy stuff. I better print the article and read it carefully.”

      Alas, I was disappointed Frost is still CEO, but the post was excellent. Private equity causes substantial destruction, and it would be great if a big player like CalPERS appropriated much less to private equity.

  5. Pat

    This raises a few serious questions about the Calpers Board:

    1.) Are they aware of this?
    2.) If not, why not?
    3.) If so, do they understand the target on their back?
    4.) Do they understand this at all?
    5.) Why aren’t they protecting themselves? Even if you are for this boondoggle, it makes strategic sense to be sure you aren’t the one with the most fingerprints on it.
    6.) Are they corrupt, venal, stupid, or lazy? Or any combination of the above?

    Yeah, I’m cynical enough not to be gobsmacked that this is being considered, but not cynical enough to avoid being floored by the sheer incompetence needed to let someone clearly over her head protect her ass while hanging their’s out to dry

    1. Darius

      Do board members have individual fiduciary responsibility? Are they accountable in any meaningful way?

      1. Yves Smith Post author

        They are individually liable as fiduciaries but CalPERS has purchased fiduciary duty insurance, so unless they are grossly negligent, they are covered. However, if they approve this scheme with no budget or plans, a plaintiff would have a good case that the board has been grossly negligent.

  6. David in Santa Cruz

    The majority of the current members CalPERS Board appear to be various combinations of “corrupt, venal, stupid, or lazy.” However, the entire Board is panicked, as they should be when they can only claim to be 71 percent funded in this frothy economy by using an unrealistic 7 percent return assumption.

    Frost’s remarks (four of the Board were in the room) appear to be obsequious to the Board’s ultimate authority while attempting to lull them into going along with a scheme that appears designed to curry favors with hoped-for outside benefactors while ignoring their clearly conflicted interests. The “plan” appears to be a classic “Shock Doctrine” sales pitch being made to a Board who know that they need to “do something” but who are self-aware enough to understand that they lack the knowledge and experience to make prudent decisions in a game of catch-up from a contribution holiday that happened nearly 20 years ago.

  7. Tom Stone

    Thank you for this, I spent the day dealing with the medical industrial complex and reading the text gave me a good laugh.
    I have encountered people like Marcie Frost over the years,most of them had degrees from Ivy League schools…
    Someone IS that stupid, always.

  8. Doug Hillman

    “Emerging” sounds like a weasel-word for undeveloped, untested, unproven, and probably unstable, like “emerging markets”, not a great selling point. Likewise “Innovative”. After the alphabet soup of failed innovations in 08, CDSs, MBSs, SIVs, and derivatives thereof how could a legitimate board fall for it. This is amateurish and smells so raunchy, you have to wonder about outright graft and fraud.

  9. The Rev Kev

    Frost sounds like she is only giving a ‘fair warning’ to the Board about these entities that she wants to set up. If the Board has no authority over these entities but is responsible for any under-performing or ‘bad behaviour’ on their part, it sounds like the worse of both worlds – no authority but all responsibility. CaLPERS may carry fiduciary duty insurance but based on what I read, I would not want to bet my house that they are going to be covered when things come unstuck.
    In line with this, you gotta love the bit about how “…they are ultimately accountable for decisions that happen at CalPERS.” Maybe the Board can do a teleconference call to Federico R. Buenrostro to ask him how well stuff like that works out. Personally, I would rather sign a blank piece of paper at the bottom of it. And that incoming Chief Investment Officer Ben Meng better make sure of just what his actual job is and that it does not also consist of being the fall guy. He wouldn’t be the first. If this goes ahead it will sooner or later blow up – and it will blow up – and at that point they will be looking for someone to hang out to dry.

  10. Donna Snodgrass

    This is the worst thing the CalPERS board has considered since they approved the scheme to allow members to “borrow” from their retirement account to make down payments on homes. This created 100% financing coupled with sub prime loans. I know 2 personally and heard of several more who lost their house and retirement when the crash came. They are still working, now in their 70s, to earn back the service credit they lost.

  11. Retired

    Yves, please keep pounding away on this topic. Your comment here is spot on:

    “The lack of a rationale for a costly and unprecedented restructuring raises red flags that the only people who will come out ahead are insiders.”

    The consultants that advised on this are the insiders that will benefit from this move. Then watch staff leave for much larger paychecks at this new entity.

  12. fries

    “Emerging Manager Program.” Would these be investment managers that have never been enrolled in an undergraduate degree program?

    “…in Silicon Valley…that would be a playground for us.” Would that be the playground with the sharks in the wading pond?

Comments are closed.