CalPERS should start to recognize that our hounding of the giant pension fund is to prevent it from doing things that will harm beneficiaries. The fact that the fund’s top management nevertheless seems determined to keep doing things that are at best wrong-headed, and too often are dishonest and obviously corrupt, should be getting a lot more attention from the mainstream press. As we’ll explain, CalPERS escaped being snared in a huge mess due to our intense question of clearly dodgy elements of its shape-shifting, poorly conceived private schemes by not handing all or most of its private equity investing over to a recently-establshed group under Mark Wiseman at BlackRock.
We now have two recent examples where heeding our advice would have saved CalPERS embarrassment and improved returns. The earlier one was CalPERS’ reversal on its ballyhooed plan to increase the funds it allocated to emerging managers. As we wrote on November 5:
The short version is that CalPERS, with a great deal of fanfare and board huzzahs, announced last year that it planned to increase its funding of its worst-performning private equity strategy, its emerging manager program. We said this was a very bad idea, since emerging managers (which are meant to be first time managers but these programs are really intended to favor minority and woman-owned firms) typically underperform, so there was no reason to expect CalPERS to improve upon its sorry record.
CalPERS has now gone dramatically in reverse. Staff, apparently without consulting the board, has decided to cut its emerging manager program for global equity, meaning public stocks, due to underperformance, and is dumping most managers. Staff even has the gall to treat board members as its hired hands, sending them talking points to back a policy change they had not reviewed, much the less authorized. While the information we’ve gotten doesn’t specify whether CalPERS is also cutting its private equity emerging manager program, the radical cut of emerging managers is consistent with the advice we offered in the private equity context.
Even if the private equity emerging manager was spared (and in fact may be difficult to cut back any time soon, since as we will discuss, CalPERS just more than doubled its commitment to an external private equity fund of funds manager for emerging managers), CalPERS would be well served to cut its commitment there as well, consistent with its newly-found investment discipline.
It at first looked like CalPERS would get away without being widely called out for this volte face, despite the fact that the idea of supporting emerging managers is popular with the legislature and some of the axed firms might have been able to get allies to make a stink
However, yesterday, apparently triggered by a report on Wednesday in a specialist financial publication that incorrectly called its tardy account an exclusive, Bloomberg ran Calpers Drops Most ‘Emerging’ Equity Managers as Returns Lag. In typical “the Blog That Must Not Be Named” fashion, CalPERS gave us a backhanded compliment by telling reporters they were late to the party:
Calpers spokeswoman Megan White, responding Wednesday to a request for comment, said the reduction “isn’t new news.”
With the emerging managers case, we can’t lay any claim to having influenced CalPERS’ behavior; we simply pointed out they belatedly fell in line with our recommendation.
Today, it was revealed that CalPERS managed to dodge a bullet, and here we do think we can claim some credit. BlackRock’s head of alternative investing, Mark Wiseman, was fired (both the Wall Street Journal and the Financial Times use “ousted”) for having an affair with a subordinate. Even more salacious, his wife, Macia Moffat, remains at BlackRock as the leader of its Canadian business.
Why does this matter to CalPERS? As we’ll explain, CalPERS looked determined to hand over a big portion, and potentially all, of its private equity portfolio to BlackRock for reasons that made no sense, and would at a minimum have led CalPERS to pay way more in fees. We exposed how the process was too obviously designed to favor BlackRock, despite the fact that it was a new entrant to the private equity game.
Insiders were so worried that CalPERS executives were still in BlackRock’s sway that they though CalPERS’ visible foundering over its private equity “new business model” would be used to give BlackRock another shot at a big portion of CalPERS’ funds, say by committing to BlackRock’s “Warren Buffett” style fund. Recall that one of CalPERS four gimmicky “pillars” was to set up a new vehicle to make that sort of long-maturity investment, even though experienced private equity firms soliciting investment in similar funds admit that they expect them to deliver lower returns than conventional private equity. Recall also that the Wall Street Journal reported that BlackRock was having trouble getting investors for its “Warren Buffett” megafund.
So why does the Wiseman defenestration matter? As Harvard professor Josh Lerner, who gave CalPERS advice on private equity in 2015, stressed, successful private equity firms have stable core teams. Turnover at the top is the very worst thing to have, since it usually means shakeups down the line, since a new executive will almost always bring along some loyal lieutenants who know how he likes to do things. The people who were in place often have trouble adapting and even if they don’t, they can resent their now greater distance from the throne and have an easy excuse to depart.
On top of that, the senior people at private equity funds are alway included in a short “key man” list. The key man provision is one of the very few sections of the generally take-it-or-leave-it limited partnership agreements that actually does get negotiated. In traditional private equity deals, the key man language gives the limited partners the authority to suspend or reduce management fee payments or even force a reorganization. There have only been a few case where it has come into play; even then, it isn’t clear that the limited partners did more than wring their hands. However, on a very-long-maturity fund, there would be vastly more risk of a key person dying or being unable to work, and would thus get stronger contractual protection. That appears to be the case with Wiseman and BlackRock. From Dawn Lim at the Wall Street Journal:
Mr. Wiseman’s departure triggers an automatic suspension of all new deals from that fund. The firm will have to get permission from a handful of key investors to continue investing. BlackRock said Mr. Kapito, the firm’s president, would become chairman for that fund, and investment decision-making remains unchanged as the firm remains committed to the strategy.
Wiseman’s exodus is even more disruptive than for a mature private equity firm. He’d come over from one of Canada’s public pension funds in 2016 to launch a large-scale private equity operation. BlackRock can’t begin to have the bench depth of an established firm and would still be partly in start-up mode. Moreover, Wiseman was 49. Given how young the operation and he was, it is also unlikely that there is meaningful succession planning in his business.
Contrast this shambolic outcome with how overeager CalPERS was to get in bed with BlackRock.
CalPERS staff falsely presented Wiseman as an unbiased private expert at a July 2017 offsite; did not tell board of a massive conflict of interest, that CalPERS was preparing to (or more likely already had) started preliminary talks with BlackRock. Note that CalPERS staff also presented Silicon Valley fixer Larry Sonsini as an independent source advice when he all too shortly was in CalPERS’ employ.
In early September 2017, Bloomberg broke the story that CalPERS is planning to outsource all of its private equity business to BlackRock. CalPERS hadn’t told the board, a serious breach. We explained why this idea was certain to cost CalPERS more in fees without a realistic prospect of better performance.
CalPERS tried to improve appearances, at least to the board, by organizing a sham, largely closed solicitation designed to favor BlackRock. Among other things, the invitation letters, which went to only six firms, went out on December 219 with proposals due in January 19. As we noted:
The “Private Equity Strategic Partner” and “Proposal Questionnaire” documents at the end of this post make clear that staff is in such a hurry that it hasn’t sorted out exactly what it wants except it wants out of private equity. This sort of “fire, aim, ready” that leads to massive self-inflicted wounds.
CalPERS is letting the supposed respondents define all of the critical elements of the arrangement, making CalPERS a stuffee. It also puts CalPERS at a disadvantage to the extent that it actually bothers trying to negotiate the agreement, since the “partner” will presumably provide the investment agreement, when any competent attorney would insist that CalPERS draft it (one of the cardinal rules of negotiating is “he who controls the document controls the deal”).
Needless to say, the fact that there is no proposal that “partners” are bidding on, but instead a “tell me what you think I should want” means the board has not approved this process. We have confirmation from inside sources.
As you can see, the schedule has the board approving vendors when it hasn’t even approved the content of the proposal!
Insiders told us that the process fell apart when BlackRock submitted a bid that was much higher than any of the others. Yet despite that troubling fact, some still feared that CalPERS’ inability to get out of its own underwear with its newfangled “private equity business model” could lead CalPERS to try again to hand the whole shooting match over to BlackRock. So Mark Wiseman’s career suicide was well timed, at least from the perspective of CalPERS beneficiaries and California taxpayers.