JJ Jelincic: CalPERS’ Plan to Create 2 New Private Equity Companies, Give Away Billions With No Control Makes No Sense….Except to Make Fund Managers Rich

By JJ Jelincic, a former board member of CalPERS

The new CalPERS Private Equity Business Model (which used to be “CalPERS Direct” even if it never was) is in trouble.

It simply makes no sense. Both Marcie Frost, CalPERS CEO, and Ben Meng have acknowledged that they don’t know if the model will work and even if the model works they are not sure CalPERS can execute it.  For instance:

Staff has offered no explanation how small startup companies can find opportunities the major players with many more employees cannot find.

Staff has offered no explanation how these startups, whose goal is to acquire assets i.e. get more private equity exposure, will show any price discipline.

Staff has said Pillar IV (“Warren Buffett style investing”) will have higher costs and lower returns than traditional private equity. (Staff has said very little about Pillar III, “late state venture capital”. Does that reflect even greater ignorance about venture capital?) How does that lead to greater returns?

If you can’t even offer a basis for expecting the model to accomplish its goals, why do it? Where is the payoff and who gets it?

The focus of Pillar Ill will be late stage venture capital in technology, life sciences and healthcare.. It is interesting to note that staff has not even claimed that Pillar III would have above market returns. This actually does make sense since the real gains in venture capital go to the early investors who take the risk. The staff has offered no theory why a developed company that is private only to avoid the exposure and scrutiny of the market is likely to have above market returns.

The agenda item now posted on the CalPERS website under Benefits and Risks, states:

Risks relate to the ability to identify partners that will ultimately be successful executing the strategies, the ability of partners to build adequate teams, reaching adequate scale to reduce the operating budgets below the typical management fee costs associated with typical partnerships and the potential capital concentration in the eventual investments.

It is worth noting that staff has found a venture capital plan and a private equity plan that have no risk that the underlying investment may fail. Or at least that the odds are so low they are not worth mentioning. Truly a miraculous development.

However, Attachment 1 does identify some risks and mitigation strategies.

Reliance on Key Partners

  • Dependent on top-tier Partners who can further define and execute strategies
  • Must be able to build new teams from the ground up while having a successful track record (in some other venture someplace else?)

To Mitigate

  • Careful selection and diligence is essential
  • Must act quickly so CalPERS doesn’t lose its future billionaires in waiting

Investment timelines vs Partner Commitments

  • Initial commitments will have fixed terms that are likely to be shorter than the time to realize returns on investment.

To Mitigate

  • Create permanent structural commitment to strategy
  • Align incentive with Partners to focus on long term performance

Return Dilution

  • Longer hold periods may ditute the high annual returns seen in short-hold gravitate equity

To Mitigate

  • Consider potential dilution in benchmark setting
  • Utilize longer-term metrics to supplement performance metrics

The attachment also notes that realized drawdowns and volatility are lower than the capital market assumptions. Staff has acknowledged, since at least the Private Equity Workshop in 2015, that these outcomes result from favorable accounting treatment. If you only mark to market quarterly and the marks are set by a manager getting paid, in part, based on assets under management one should expect lower write downs and volatility. On several occasions staff has acknowledged that “observed volatility” is a measurement problem. No rational investor believes that leveraged small cap equity is less volatile than a large cap index.

So look at what they are putting forward? A program based on misleading accounting. CalPERS needs to act NOW or the potential billionaires will go away. (I guess the staff forgot about Meng’s presentation on stock pickers). CalPERS needs to make a structural commitment. (So much for a “conceptual” approval.) The CalPERS “long term holds” will not be long enough to realize returns so it must align incentives to focus beyond the investment period. (Neat trick. I wonder how?). Because of lower returns CalPERS will need to cut the benchmarks even further. How does any of this make sense?

At the February 28, 2019 California State Retirees Board meeting, Frost disclosed that she had been directed by Bill Slaton to bring the pending CalPERS Private Equity Model to the March Investment Committee for “conceptual approval.” That instruction appears to have been given in closed session.1

Over the last two years staff has repeatedly and publicly claimed that the Board had “approved” the new Private Equity model. When pushed by the Board, the press and/or constituents, the “approval” amounted to “Well, they didn’t tell us to stop.”

Now not rejecting is no longer enough. Now the Board needs to give a blank check to staff and approve the model “in concept.” This is interesting since John Cole has already said staff could implement the new model within its current authority. The next time this issue comes before the Board, staff will rely on “as you approved in March.”

Why does Frost need this blank check? She says it is to convince the market that CalPERS is serious. As Frost said:

But what we need to do is signal the financial markets that CalPERS is interested in exploring this concept more, to see if we can actually execute it. That’s what we need to send out to the financial markets because the way that we make this successful is being able to find the right team to work with us and then talk about….

And the reason that signaling the financial markets is important is that when we’re out looking for teams or looking for talent, we have to be serious about execution. And the way that we do that is that we have to have the board make a prudent public comment or take an action that says, “Yes, we want to see if we can be successful.

As Dr. Ashby Monk, the executive and research director of the Stanford Global Projects Center, who was invited by staff to speak twice to the Board, said (my emphasis):

Because most people in the world today don’t grasp the sheer sale – scale of the compensation we’ve paid to these external managers. It’s often hidden in footnotes. It’s often buried in NAVs. And that lack of transparency has limited the amount of innovation that we’ve had. That transparency project of you all have realized and has start here a few years ago when the true cost came forward, drove this Board to say is there another way? And that is the best thing we could have had happen. Because the fastest path to becoming a billionaire in America today is not starting a tech company, it’s starting as asset management firm, okay, by a factor of two.

So given that CalPERS is trying to create billionaires by setting up their companies for them, why does CalPERS need to signal the markets? It’s because the market doesn’t believe CalPERS. Every time this so called Private Equity Model is exposed to sunlight it changes. The result is neither the beneficiaries nor the market are sure what CalPERS wants them to believe.

It is possible that the market does not believe any fiduciary who has his or her personal net worth at risk would even consider:

  • creating a startup asset manager and giving it away,
  • agreeing to pay all expenses of the new firm,
  • setting up a non-owned LLC2to invest with that manager,
  • giving billions to the new manager while retaining no ownership of the assets,
  • not knowing when any cash may come back to the system, and
  • having no control of the assets.

Yet that is exactly the concept staff is asking the Board to approve. Have you ever wondered by public pension plans are often seen as “dumb money”?

If I asked to manage your money on those terms how long would it take you to throw me out? Yet the Board members are legally required to act as prudent experts – a very high standard.

The Law? What Law?

Don’t forget what the California State Law which created and defined the trust says.

California Government Code § 20120:

The management and control of this system is vested in the board

California Government Code § 20170:

The Public Employees’ Retirement Fund in the State Treasury is continued in existence.

The Public Employees’ Retirement Fund is a trust fund created, and administered in accordance with this part, solely for the benefit of the members and retired members of this system and their survivors and beneficiaries.

California Government Code § 20171:

The board has the exclusive control of the administration and investment of the retirement fund.

California Government Code § 20190:

The Board has exclusive control of the investment of the retirement fund.

The Board may lack the legal authority to give away the assets of the fund.

Governance? What Governance?

Both Dr. Ashby Monk and Frost talked about the importance of governance.

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 over time.

Marcie Frost had also said:

Governance. Governance very important. And I know that we’ve been looking at governance structures for a bit of time and will continue to do so.

While the issue of governance is still undecided, it seems that given the law it is unlikely that proper governance is achieved by placing assets beyond the reach and control of the Board. Abdication is not governance. Yet this is what is being proposed.

When board member Margaret Brown asked about increasing the transparency of the plan to the Board and the beneficiaries, her answer came from Matt Jacobs, CalPERS General Counsel:

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.

Why should the trust beneficiaries care? It is only their money.

So staff is seeking approval “in concept” for a model that is still in the process of being defined.

Staff has asserted but offered no reasonable basis to claim the model will actually achieve the goals being set out. The “model” has still undefined controls and governance.

The model has not been submitted to a prudent person opinion which makes sense since it is impossible to opine on an undefined program.

The costs remain undefined. It may be a reasonable experiment if it costs $100,000 a year. It does not make sense if it costs $10 billion a year.

Staff has not refused to answer Board questions; it has simply found it easier to ignore the questions. After all the staff has already given the Board their marching orders.

Three months ago, I described how CalPERS staff was unable to present any payoff to beneficiaries from the proposed private equity plan, that, for instance, there was no clear payoff from higher net return and no clear payoff from putting the trust assets beyond the control of the Board. Today, we are still wondering who benefits. Given the continued failure to explain why this plan could rationally be expected to help CalPERS’ beneficiaries, staff should not be surprised that independent parties are wondering about bad motives, particularly in light of the Al Villalobos/Fred Buenrostro bribery scandal.

At best, it is way too early to approve this so-called model even in concept.


1 I must assume that Slaton will be pursuing discipline against the CEO. After all, he once sought to have me disciplined for a passing mention of a SEC investigation of CalPERS insider trading. He claimed it was attorney-client and closed-session privileged even though the Sacramento Bee had written about it three years earlier.

2 John Cole has said that CalPERS would be the “sole member” of the LLC it uses for these funds but will not own it. That makes no sense. The members of LLCs are all owners. In addition, an LLC must have a manager who may or may not be a member. According to LegalZoom:

Not all LLCs have a managing member; in a manager-managed LLC, the members own the company and the manager is a non-member employee who runs the company. A managing member of an LLC is an individual who holds an ownership interest in the company, participates in its day-to day management and has authority to contract on behalf of the company.

Cayman Islands law on LLCs is modeled on Delaware law, so there’s not much reason to think there is a Caymans angle that would change this picture.

So it appears that CalPERS doesn’t know what it is talking about even on this basic issue and is hiding important information, like who would manage the LLC(s).

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  1. pretzelattack

    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.

    well who could fail to be convinced by that.

  2. The Rev Kev

    After reading JJ Jelincic’s account of what is happening at CalPERS it gets so recognizable and I think that I recognize why. The author Dean Koontz once wrote: “The problem with movies and books is they make evil look glamorous, exciting, when it’s no such thing. It’s boring and it’s depressing and it’s stupid. Criminals are all after cheap thrills and easy money, and when they get them, all they want is more of the same, over and over. They’re shallow, empty, boring people who couldn’t give you five minutes of interesting conversation if you had the p***-poor luck to be at a party full of them….” He has a point.
    And they are stupid. California has about 120,000 people in their State’s prisons. How many of them said to themselves “They’ll never catch me!” before committing their crime? I have been giving this investment scheme a bit of thought and I had an idea. I was inspired by something that Bill Black once wrote. His book “The Best Way to Rob a Bank Is to Own One” gave me the idea. CalPERS could set up their own bank! I can see it now. The Bank of CalPERS. No, no! Make that The CalPERS Bank! it even has a nice ring to the name. They could even use the CalpERS logo here for their own Bank. Wait, I can even see their motto. How does this sound? “AAAAnd it’s GONE!!!!!!”


    Why CalPERS could even use that film clip as a training video. They could derive their own doctrine from it. It would be glorious. They would be even in their own element. They could adopt Bill Black’s idea of “control fraud” which I am sure is about how to make sure fraud does not get out of control. They could set up branches in Washington DC (for political cover), New York (to teach them the ropes) and another in Andorra (for when it all blows up). If they do not like that last choice I am sure that they could find another one at https://nomadcapitalist.com/2013/06/03/the-best-non-extradition-countries-to-be-invisible/ if need be. CalPERS could even slip something into the literature that the Government of California will automatically bail them out in case anything “went wrong” with the whole scheme. And if there was anything illegal about any of this setup, I am sure – and I am stealing from another commentator here – that Attorney General Becerra would be all over it.

  3. Larry

    Thanks for the excellent piece JJ. I only hope that some influential people see this and take action.

  4. Clive

    Confidentiality, the last refuge of the scoundrel.

    CalPERS staff is asking the board and the beneficiaries to swallow the idea that these fund managers are so clever that they’ve spotted hitherto well hidden investment opportunities (which in itself is a strange idea because just in my TBTF there’s at least a thousand people in each of the insurance and wealth management teams looking for just such unicorns, sorry, I mistyped, off-the-radar deals; when you add in all the other banks, insurance funds, pension funds, PE and hedge funds, Warren Buffett and Buffet wannabes, sovereign wealth funds and my mother-in-law it is well into the millions of professionals and even more numerous amateurs) and also can’t even come up with a straight answer about what their total above the line take will be.

    I mean. Do they think we’re stupid or something?

    It all sort of reminds me of when I flick through the pages of various lifestyle magazines aimed at the rich and, I have to assume, easily duped, whereby a piece of residential real estate is advertised as being “off-market” whereby a seller wants shot of some property millstone which is unceremoniously hanging around their necks but doesn’t want to admit how much they overpaid for it or what outrageously silly money they are trying to get for it. Realtors, which can are like the fund managers in the CalPERS shoddy scheme, of course get to make their cut no matter whether the buyer ends up overpaying or the seller gets away with offloading an otherwise unsalable dog which doesn’t have to withstand the scrutiny of true price discovery.

    I wish I could think up these sorts of scams. Then I’d be sitting in my ocean view beach house or high floor apartment overlooking Central Park instead of sitting here typing this. I always was too honest for my own good.

    1. Off The Street

      I mean. Do they think we’re stupid or something?

      CalPERS people don’t show evidence of that much discernment. They seem more into following fads and trends that fall into their echo chamber, after a nudge on those fads and trends by consultants and bankers. A less-supine board would help members.

      1. Jennifer

        They don’t care if we’re stupid. They are stealing our retirement fund, handing it over to who knows who and we’ll never get it back. The legislators better put the brakes on this theft and right now. Mr Slaton has no business on the board as his term is up. Much less demand this be brought to the committee and board in March. He is well aware he can jump in behind a CalPERS investment just a few days after it is made. While he was part of the rule making to hide investments from members stating they didn’t want to be making buys/sells and causing market moves. There are new board members who haven’t been read into this scheme and can only rely on the misleading staff. I hope enough of the board members see this for what it is, a get rich quick scheme brought to CalPERS by a well connected high school graduate. Remember Mr. Meng is on probation and must do as his boss says. Look what happened to Elisabeth.

  5. human

    It continues to boggle my mind that Frost wants to give away the store and so few call the empress on her new clothes. Wall street has always wanted pieces of CalPERS

  6. EoH

    “Concept approval.”
    The board “didn’t tell us to stop.”
    An oversight is for fools blank check “to convince the markets that CalPERS is serious.”

    Every used car salesman in the land sees CalPERS coming and is already planing on how to spend his bonus.

    “Starting an asset management firm” is a surer way to become a billionaire than starting a tech company. One reason is because it avoids much of the technological, competitive and business risks. Another is that it permits the manager legally to milk the investors and target companies until his investment cows are fit only for the knacker’s yard.

    The description of CalPERS’s behavior reads as if it came from an indictment. And if I were the general counsel of a large, sophisticated, publicly owned retirement fund, with the resources to obtain the best possible advice, to act on it, and to structure its investments virtually any way it chooses, who said this about transparency and fiduciary responsibility,

    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.

    I would worry about keeping my law license.

    1. Sacramento Sal

      I recall a previous post on NC that the CALPERS board and staff have procured some sort of Fiduciary insurance to protect them individually from their own stupidity.

      Maybe this is why the staff and board think its okay to roll the dice on this looser.

  7. Jim A.

    Why does Frost need this blank check? She says it is to convince the market that CalPERS is serious.

    A more suspicious person would think the looters will stop the kickbacks and fancy dinners etc if they don’t think that they will see the money. That they have hinted to Frost that she has to put out or get out.

  8. Retired

    JJ, great article and explanation of what CalPERS is doing. This plan should be killed immediately and stop wasting staff’s time on something that will not help the underfunded status.

  9. Tom Stone

    If only Attorney General Becerra’s staff wasn’t overwhelmed pursuing 47 lawsuits against the Trump Administration he’d be all over this!

  10. notabanker

    Very important context here:

    I don’t understand how any current Board member would take on the risks of this scheme. Personally, I’d resign my Board position, even if I had personal liability insurance. There’s no way I would take my chances in the CA law system on this issue. Especially with the country moving left.

    The Bourqui was brilliant to get out of there. These people are risking everything on this scheme.

  11. flora

    Thanks very much for this great post.

    shorter CalPERS plan:
    ‘Step 3: Then a miracle occurs.’ (old joke)

    This comment by Auerback/Das about a similiar (imo) sort of scam, uh, plan (not PE) being run in the UK against municipalities sounds very like CalPERS “great idea” (no oversight, long terms, no protection, fund skimming, large financial losses):

    In theory, the risk is dispersed, but in practice, as Das has pointed out, if you’re simply diversifying different kinds of financial excrement, the end result is more likely to be insolvency for the whole instrument. …Consequently, more toxic junk is being passed around the system like a hot potato. Last one holding the potato loses.


    Mr. Jelincic asks the key question, imo, about this latest CalPERS scheme:

    ” If you can’t even offer a basis for expecting the model to accomplish its goals, why do it? Where is the payoff and who gets it? ”

    Thanks very much for your continued reporting on CalPERS,PE, and pensions.

  12. sawdust

    Because the fastest path to becoming a billionaire in America today is not starting a tech company, it’s starting as asset management firm, okay, by a factor of two.

    This is an all time statement. She can’t even think through where asset managers fees come from. I think trying to find excess return on $350 billion is silly given how the marketplace works. Is there any research or evidence looking at these size investors?

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