CalPERS is having trouble getting anyone reputable to endorse its unorthodox, risky private equity scheme. the centerpiece of which is to create and fund two new large fund managers that would be completely unaccountable to CalPERS.
The idea should have died a long time ago, but CEO Marcie Frost is still desperate to get it done, despite staff members admitting in a November board meeting that CalPERS’ newfangled companies would have higher costs in the early years and would also generate lower returns than conventional private equity funds. This is tantamount to an admission that CalPERS board members, executives, and consultants would be violating their fiduciary duty to CalPERS if they were to let this plan go forward.
As we’ll show below, one of the experts that CalPERS has now had in twice, with the apparent aim of helping to persuade the board to approve this obviously bad idea, has taken the unusual step of publishing a long tweetstorm shortly after a presentation at CalPERS last week that makes clear that he is opposed to CalPERS’ plans. Mind you, Dr. Ashby Monk is too polite to say, “CalPERS needs its head examined,” but if you look at his forceful and clear recommendation, it is the polar opposite of Marcie Frost’s private equity plans.
Even though Dr. Monk has made clear his general position on private equity for a long time, it seems noteworthy that he felt compelled to give a one-stop-shopping version on Twitter later in the very same week that he spoke at CalPERS. Recall that this was the second time Dr. Monk has spoken to CalPERS board. We pointed out that CalPERS had snookered Dr. Monk the first time he presented:
CalPERS has even gone so far as to mislead its own cheerleaders. The pension fund invited Dr. Ashby Monk of Stanford to speak at a public board meeting in August, and Frost quotes Dr. Monk in her promotional article. Dr. Monk took a generally positive tone but pointed out that what CalPERS was planning to do was not direct investing, which means having CalPERS staff make private equity investments itself, but was forming its own general partners. Dr. Monk then described how some large investors had used “pick the pickers” methods to assure that the board was loyal to the organization that provided the money.
I spoke with Dr. Monk for a half-hour after his CalPERS presentation. He acknowledged in our conversation that CalPERS had not disclosed to him that the board of the new entity would be chosen by its management and CalPERS would have no say in the board’s selection. Thus he cannot be deemed to have approved what CalPERS is doing, since he was misinformed.
We pointed out in this same October post that CalPERS has featured Dr. Monk prominently in a brochure to CalPERS beneficiaries as if he were supportive of CalPERS’ plans. Reader Brooklyn Bridge pointed out that even with CalPERS’ cherry-picking, Dr. Monk’s support had actually been so heavily qualified as to be empty:
“But as Dr. Monk said, “I’m encouraged that if you can get the governance right, if you can evolve this into a platform that can recruit the right talent, you can succeed.”
Even as a total know nothing, I would see pure bunk in this line alone (never mind, “We’ve listened to our Stakeholders”… and they want dumb, dumber and dumbest). It might as well read, “I’m encouraged that if you succeed, and succeed well, you are well on your way to success!”
The title should be, “Taking aim. Exploring a new Private Equity Mark“
Below is Dr. Monk laying out his recommended private equity to public pension funds…and this recommendation is the polar opposite of what CalPERS has been trying to get its board to approve. It’s unlikely to be a coincidence that he posted this tweetstorm within days of visiting CalPERS:
This is a recommendation to bring private equity in house, period. As we have said repeatedly, that is the polar opposite to what CalPERS is trying to do, CalPeRS wants to create new investment vehicles which will be even riskier and less accountable than inventing through private equity fund managers.
Dr. Monk also points out that if your are serious about ESG (emphasizing environmental, social, and governance investing), you need to run your private equity investing in-house. Recall that CalSTRS had a long and uphill to get fund manager Cerberus to sell its stake in a firearms maker. That’s only one holding. Consider this part of a clearly unhappy 2015 press release:
Although Cerberus committed to sell its holdings in Remington Outdoor, thus far that pledge has not been fulfilled. As we continue to push them on this front, we have also worked to exercise patience and give them time to execute what is a complicated transaction.
But we understand the patience of our membership wears thin. Unfortunately, as a limited partner in a private equity investment pool controlled by Cerberus, CalSTRS has very limited rights. Contractual obligations and legal constraints severely limit our options to exit this investment.
More importantly, we cannot take unilateral action, in this case, to remove a specific company from an investment pool. Nor can we expose the fund by prematurely or imprudently selling about $375 million worth of holdings at a loss without thoroughly exhausting all other options first. While we cannot share the details, we want to make it clear that all potential options are being fully considered and have been for some time.
Even though we don’t have the same level of enthusiasm for ESG investing that CalPERS does, the point is that CalPERS pretends to be serious about it, and it can’t be if it is investing through third-party managers. It can only have very limited firm prohibitions; otherwise, it constrains the investment universe and becomes an unattractive funds source.1
Dr. Monk’s tweetstorm came after he repudiated another central element of CalPERS’ scheme, that of its lack of transparency. Recall that CalPERS now provides limited information about all of its private equity investments every quarter, such at the commitment amount, the total funds invested, and the returns, expressed as IRR and investment multiple. That disclosure came about as the result of a settlement with the Mercury News in 2002. Many other public pension funds now provide similar fund-by-fund information. One of the important aims of Marcie Frost’s private equity plans are to end this and other disclosures.
Recall that at last December’s board meeting, General Counsel Matt Jacobs stated that the purpose of the new private equity scheme was secrecy (see 3:36:58):
Board Member Margaret Brown: Mr. Cole, you know that this Board has a fiduciary responsibility to 1.9 million members and thousands of employers. And so with that in mind, I wanted to let you know that I have a lot of concerns that we are putting this program together, I think, in part to avoid transparency, Bagley-Keene, the 700s, and the Public Records Act request.
And so what I’m wondering is since CalPERS is drafting the agreements we could, in fact, make them — at
least due to a Public Records Act we request, we could, in fact, require that of our partners in these companies could we not, since we’re drafting that agreement? Oh, good. Mr. Jacobs, we’ll have him come up and answer.
Investment Director John Cole: That’s a legal question.
Board Member Brown: Yeah.
Investment Director Cole: I don’t want to get out of my lane
General Counsel Matt Jacobs: Well, at a high level, I suppose we could. I think that would defeat the entire purpose of the endeavor that the Investment Office is undertaking, which is that these are private investments, and they’re private for a reason, which is that the — the financial information needs to be private. And the people running them have these types of preferences.
A little more than a month later, at the board’s offsite meeting on January 22, one of the private equity experts invited to speak, Dr. Ashby Monk, blew up the CalPERS’ claim that secrecy is necessary and desirable at 1:31:10: “I’ll offer some bit of extreme views. I think there is no balance. 100% should have ESG and transparency.”
And CalPERS has also used as a defense that private equity funds don’t like transparency. Mind you, we’ve had the limited partnership agreements of many of the biggest fund managers posted on our site for years and none of them appear to have suffered as a result of these supposed trade secrets getting out in the wild.
One of the amusing spectacles at the offsite was Jonathan Coslet of TPG trying to pretend that the over-the-top secrecy requirements for private equity limited partnership agreements was somehow the doing of investors and TPG was perfectly fine with everything being out in the open. Starting at 1:06:30:
Board Member Margaret Brown:: As you may know, we have been having open discussions about the secrecy of private equity agreements. And I understand that the Pennsylvania state legislature has recommended substantial narrowing of the laws that exempt from FOIA the entire contracts between private equity funds and investors like public pension funds. I am curious in TPG’s case investors or TPG was harmed by the release of what I understand was one of your agreements by the Pennsylvania state Treasurer. Just wondering. Several years ago that happened, it was out in the public domain and I’m just wondering if there was any harm to investors or to TPG when that happened.
TPG Chief Investment Officer Jonathan Coslet: I can’t really comment specifically, but my sense is that our perspective would be that we want to respect the confidentiality that you would like and if you our clients would like confidentiality, confidentiality with what is essentially a private contract, we would like to respect that. Different organizations have different feelings about that. We have sovereign wealth funds, insurance companies, endowments, pension funds, individuals. So we just want to respect the confidentiality our clients would like.
As Dr. Monk said to an audience member later, this claim was completely false. Private equity fund managers have fought fiercely to keep their limited partnership agreements secret, absurdly claiming the entire agreement to be a trade secret. This systematic shielding of these agreements started, ironically, in the wake of the 2002 Mercury News settlement with CalPERS that we mentioned earlier. Private equity firms went to every state and got either legislation or state attorney general opinions shielding private equity agreements in full from disclosure. Even now, these alternative investment agreements are the only contracts that state and city governments enter into that are secret.
We gave a long-form debunking of the idea that anything in private equity agreements could be considered a trade secret in 2014, when we published a set of private equity agreements that the Pennsylvania Treasurer had on its website with no password protection. That includes the TPG contract that Margaret Brown mentioned. A key section of that post:
For decades, private equity (PE) firms have asserted that limited partnership agreements (LPAs), the contracts between themselves and investors, should be treated in their entirety as trade secrets, and therefore not subject to disclosure under Freedom of Information Act laws in any jurisdiction. These private equity general partners argued that the information in their contracts was so sensitive that it needed to be shielded from competitors’ eyes, otherwise their unique, critically important know-how would be appropriated and used against them. In particular, PE firms have made frequent, forceful claims that their limited partnership agreements provide valuable insight into their investment strategies. The industry took the position that these documents were as valuable to them as the formula for Coca-Cola or the schematics for Intel’s next microprocessor chip.
You can see why Dr. Monk was unable to contain himself when Coslet served up such nonsense with a straight face. But the flip side is that this revisionist history is the new party line in private equity, that the general partners know they don’t have a leg to stand on in trying to continue the pretense that they have a legitimate business need for their secrecy regime. It may be that general partners recognize that the Pennsylvania disclosure recommendations have breached the levee, and there’s no standing against the wave of changes that will follow.2
So if CalPERS can’t even get supposedly supportive experts to back its plan, pray tell how can its board go forward without putting a huge “Sue me” target on their backs? I bet Bill Lerach is quietly hoping they don’t figure that one out.
1 As much as we applaud some of what Dr. Monk says, we also have to note that he goes to considerable lengths to cater to the needs of investors that are his prospective clients, unlike academics who focus on private equity like Oxford’s Ludovic Phalippou, or Eileen Appelbaum and Rosemary Batt.
Specifically, Dr. Monk notably sidesteps the real reason for bringing private equity in house. It isn’t that public pensions funds all over America have suddenly become camp followers of Alexandria Ocasio-Cortez and have decided to get out of the billionaire-creation business. No, it is that private equity net returns are falling and investing via private equity funds no longer earning enough on a risk-adjusted basis to justify investing in the strategy. It’s truly disturbing to see Dr. Monk effectively support the public pensions funds’ “absolute return” fallacy, when no intellectually honest finance professional would indulge it. The only way to have private equity deliver adequate net returns is to considerably reduce the fees and costs of private equity investing by doing it in house. And those charges are so ginormous that doing it yourself, even though it will take time to get there, ought to be seen as a no-brainer.
It is also bogus to depict equities of any sort a long-term investments that better fit the long-term liabilities of pension funds. In the hoary days of my childhood, equities were recognized as highly speculative. Bonds were the preferred investments for pension funds because bonds, with their fixed payments of interest and principal, could be laddered to meet the projected liabilities of pension funds.
The reason for higher equity allocations has nada to do with them not having fixed maturities. Equities were added because they have higher returns and provide diversification by asset class, which before risky assets became so highly correlated, also offered some additional downside protection.
Moreover, had Dr. Monk familiarized himself with public markets investing, he would know that one of the reasons academic studies back index investing is that the rebalancing to replicate the index forces selling of winners, as in realization of gains. Similarly, the reason private equity as currently practiced has provided high returns is the discipline of requiring realization of profit. While there are cases where PE funds buy a “growth-y” company and wind up selling it to another private equity fund who is also able to get good returns (meaning the sale from one fund to the second just resulted in paying extra transaction fees, if you look at total returns from owning that company), CalPERS has effectively admitted that this isn’t a widespread phenomenon, and that longer holding periods = lower returns. Why engage in this long-dated fund fad at all if it undermines the whole rationale for private equity, higher returns?
2 Key section from the executive summary: