It is really disheartening, with all of the bona fide scandals cooking at CalPERS, to see the Los Angeles Times devote serious reporting horsepower to a nothingburger: the fact that CalPERS has a stake in a hedge fund, which CalPERS has been trying to exit for years but hasn’t finished the process, that held a big stake in American Media Inc. and where CalPERS almost certainly still holds an interest.
Yes, THAT American Media: owner of National Enquirer, the taker of Stormy Daniels hush money from Trump’s fixer Micheal Cohen,1 and lately, the proud possessor of some notorious below the waist photos.
So why is this even a story? Dem state invested in a company that went after that paragon of American capitalism, Jeff Bezos, and indirectly that supposed icon of journalism, the Washington Post?
Wellie, CalPERS didn’t pull that trigger. It gave the money to a hedge fund manager, Chatham Asset Management, that acted at least some of the time like a private equity fund and invested in private-equity type things like private companies. And maybe because it was a private equity wannabe rather than the real thing, this American Media private-equity-type investment was a dog on top of becoming a PR nightmare…which is making it even more of a dog, if such a thing were possible.
Specifically, as many of you know, this particular private company is in a quite a bit of legal hot water, first due to the Stormy Daniels affair, which led to American Media entering into a no-prosecution agreement in return for its cooperation, and again due to its haggling with Jeff Bezos over those notorious wiener photos. Prosecutors are looking into Jeff Bezos’ claims that the American Media attempted to blackmail and extort him, which if true would be violations of the no-prosecution agreement, in which American Media said it would fly right and not break the law for three years.2
One of the particularly disheartening things about this story it skipped entirely over the fact that CalPERS was a passive investor in the fund that gave CalPERS an economic interest in American Media. CalPERS was in what was effectively a dedicated fund, which the article calls a “fund of one,” when CalPERS invested $600 million in the so-called Chatham Eureka fund. The article suggests that CalPERS had a 99% stake and Chatham had a 1% participation.
Chatham invested in American Media in 2014 when it came out of a 2010 bankruptcy. As of 2016, four Chatham funds together owned 78%, with the Eureka fund the biggest holder at 34%.
Ironically, 2014 was the year when CalPERS decided to exit hedge funds entirely. Most hedge fund interests can be redeemed by providing a notice, which can usually be done at least once a year. But the Eureka fund, with illiquid holdings like American Media, likely didn’t have typical redemption provisions. CalPERS apparently didn’t attempt to speed up the departure by selling its position to another investor. So one of the reasons CalPERS has been burned is due to its failure to be sufficiently bloody-minded about its decision to get out of hedge funds entirely.
The takeaways are:
1. If you become a passive investor and let someone else call the shots, you are going to wind up in the headlines because your fund managers will invest in stupid stuff, embarrassing stuff, and dogs upon occasion. If you bring it in house, your staff will also invest in stupid stuff, embarrassing stuff, and dogs upon occasion. However, you will at least have the ability to yell at the company’s management and dump your holding.
2. There is no formulation of the usual “behave well” rules known as ESG (“environment, social, and governance”) that would have prevented this investment. “Don’t invest in sleazy companies” would preclude Facebook and easily half the financial services industry. If you are stringent about being virtuous, there are perilous few places to put your money to work.
3. CalPERS was right to get out of hedge funds! The Eureka fund earned a measly average annual return of 2.3%, way below what it would have earned in a stock index fund or even a 60/40 stock/bond mix.
4. It is taking CalPERS an awfully long time to get out of Eureka, and that suggests whatever is left in the fund is overvalued, because if Chatham could get out at its reported value or higher, it would have done so by now. By contrast, when CalSTRS had a hissy fit about Cerberus owning Remington, CalSTRS was finally allowed to exit after two years (Cerberus did not liquidate its fund’s stake in Remington, and was holding that bag when the gun maker filed for bankruptcy in 2018).
CalPERS’ holding in Chatham, the fund that owned the American Media stake, was down to $261 million at the end of June 2016, $235 million as of June 2017, and according to the Los Angeles Times story, “over $200 million” in 2018. That means the eventual writedown could be big enough to be hard to hide and lead to another round of bad press.
American Media is still a financial mess, From Bloomberg:
The closely held American Media Inc. — led by the president’s longtime friend, David Pecker — recorded a $31.5 million loss in the six months that ended Sept. 30, according to documents reviewed by Bloomberg. That marked an improvement over the previous year, but nonetheless brought the company’s total losses over the last 5 1/2 fiscal years to $256 million. AMI owed about $203 million more than its assets were worth.
So whatever of that >$200 million value that CalPERS is still apparently claiming for Eureka that is attributable to the American Media investment should be written down to zero. I have a sneaking suspicion that most and potentially all of what is left in Eureka is the American Media stake. Not only is that consistent with the fact that CalPERS is still stuck in that fund, but CalPERS would have huffily said that the American Media portion of its remaining stake in Eureka was bupkis if that were the case.
5. CalPERS does a terrible job of trying to ‘splain itself. CalPERS seems to think, like the Democratic party, that the solution to every problem is better PR, but it just goes about looking guilty whenever those problems are investment problems.
Saying “We continue to work towards liquidating our remaining holdings and ending our relationship with the hedge fund, which currently represents 0.0006 of the more than $350 billion CalPERS fund” is lame. So what if a particularly rancid investment is a really small percent of the total portfolio? The amount of money is no measure of the harm done. What if, say, CalPERS had made a similar sized investment in a company that let the smallpox virus get back out into the wild?
And CalPERS isn’t helping itself by hiding how much of its remaining Eureka stake is in American Media. CalPERS would get a lot more sympathy if it threw Chatham under the bus, which in this case is a proper assignment of blame: “We’re frustrated to still be in this fund and the only reason we are in it is this American Media holding [if true], which Chatham has been unable to or refused to unload. We haven’t made a dime on it in years. We would have been out of this investment long before these scandals started if Chatham had respected our wishes.” CalPERS has no reason to curry favor with Chatham, but it is too chicken to criticize any fund manager, even when they fully deserve to get a bad review.
What is distressing about this story is that while the factual reporting is very detailed, it’s all about connecting CalPERS to American Media. That gives readers the mistaken impression that CalPERS was in charge. Virtually all of the tweets on the story lambaste CalPERS staff and its board for failing to investigate American Media. They were in no position to do that! What about “passive” don’t you understand?
If this story had wanted to serve the public, instead of merely taking advantage of Trump outrage, it would have stressed that this was the inevitable result of the use of limited partnerships, which require limited partners like CalPERS to being bystanders. It would have depicted CalPERS as a (perhaps too credulous) victim instead of positioning the giant fund as a perp by weighing so heavy on CalPERS as a source of funds and not explaining how it had zero control once it committed the money…and hasn’t even been able to exit more than four years after deciding to do so!
In other words, the Los Angeles Times gave the entire “alternative investment” industry a free pass. It did California taxpayers an even greater disservice by failing to mention that CalPERS plans to double down on this model by setting up dedicated private equity funds over which it will again have no control, but will still be held responsible for any gaffes, when CalPERS could instead bring the investments in house and at least be able to Do Something when things go pear shaped.
1 This is another example of Trump’s and Cohen’s incompetence at deal-making. The National Enquirer regularly shakes down celebrities over dirt they’ve discovered. But the usual “payoff” isn’t cash but an exclusive, like a photo op of their house. The Enquirer would probably have gone away happy with a tour of Mar a Lago and some interior shots of Trump’s 757.
2 For what it is worth, the highly respected Columbia law professor John Coffee took al of Bezos’s allegations as true looked at the relevant statutes. Coffee concluded that what American Media did, although “reprehensible,” was neither extortion nor blackmail. But that doesn’t mean an ambitious prosecutor won’t have a go at American Media.
3 Mind you, we don’t think all that much harm was done. Specifically, even if the Stormy Daniels scandal had gotten into the news during the election, it would not have changed the outcome. Trump married two swimsuit models and was cheating on Marla Maples before he divorced her. His playboy habits were already baked into the price.