Yves here. Long-standing Naked Capitalism readers may remember Nanea, who provided some very important posts early in our coverage of private equity, such as Private Equity: A Government Sponsored Enterprise and Private Equity Collusion on Deals. Nanea has returned and graciously offered to give his expert reading on a CalPERS investment as the sole, $1.5 billion investor newly-formed private equity firm called LongRange Capital.
This investment has become controversial due to it strongly resembling CalPERS so-called Pillar IV strategy from its “private equity new business model” which was to stake a new private equity fund, with CalPERS approving its annual operating budget, and the fund investing in the dubious “long-term Warren Buffet-emulating” strategy.
CalPERS’ determination to pursue this approach contradicts its justification for seeking to increase its private equity commitments, that it need higher returns. Not only is the notion that private equity outperforms a canard, seasoned private equity sponsors state clearly in their marketing that long-term funds will deliver lower returns than conventional private equity funds.
As an article by Justin Mitchell, Board member questions $1.5bn CalPERS commitment to LongRange debut fund, in Buyouts described, the investment looks like a poke in the CalPERS board’s eye. State Treasurer Fiona Ma proposed an amendment to a resolution on the Pillar III and IV strategies, requiring the CalPERS staff to bring specific Pillar III and IV strategies to the board for approval. Board member Margaret Brown further got CalPERS staff to agree not to try to circumvent the requirement for board approval. From the article:
At the March 2019 meeting where the pillar plan was approved, Brown pressed investment director John Cole and former CIO Ben Meng to pledge that pillars III and IV would not be executed as a series of smaller commitments understaff’s delegated authority.
“My concern is if you ended up doing five pillar IIIs and five pillar IVs, all less than $2 billion, with this approval today, you could move forward under the current delegated authority,” Brown said to Cole on March 18, 2019. “And that’s a concern I have. And I want to hear you commit today that that’s notwhat you’re going to do.”
“We commit to that,” Cole said.
CalPERS effectively conceded that the board hadn’t approved the investment, which is consistent with the lack of it having been put on the agenda of a board meeting. The only defense was Board President Henry Jones claiming the board was “informed,” which is not at all the same as having considered and voted for the investment.
The article pointed out, and Nanea confirms below, that if the board revoked its delegated authority to staff with respect to a Pillar III or IV type investment, its commitment to the LongRange Capital fund looks to be legally invalid.
Nanea found other red flags concerning LongRange Capital, the biggest being that its founder Bob Berlin has been effectively unemployed. His most senior position in private equity was actually serving as part of a private equity team in a hedge fund, and since he was not the head of that team, it’s an open question as to how much of the performance can be credited to him. The firm also had no other employees prior to about a week ago. Recall that first funds typically underperform.
On top of that, Berlin is already demonstrating problems with honesty: he’s claimed multiple starting dates for his fund, and almost certainly also lied on his new firm’s first SEC Form ADV filing. We rejected the alternative explanation, that is CalPERS its irredeemably idiotic and agreed not to have his fund audited. But maybe CalPERS was that much of a chump. Nanea confirmed that CalPERS accepted bog-standard provisions, meaning unfavorable to CalPERS, when it clearly had leverage to do much better.
This episode is yet another example that CalPERS CEO Marcie Frost will tell a lie even when the truth will do. Frost knows her captured CalPERS Board will simply nod and go along with whatever she puts in front of them, even when it will obviously harm beneficiaries. So why not handle this investment in a straight-up manner and have the Board take a vote? Just like Donald Trump, as the star of her own reality TV show, can’t submit even to a ritual of asking for permission.
By Nanea, a private equity insider
You have asked for my commentary about the newly-founded private equity firm “LongRange Capital, L.P.” (“LongRange”) and its $1.515 billion first fund, LongRange Capital Fund I, L.P. (the “Fund”). As you pointed out, CalPERS has committed nearly all of this Fund’s capital ($1.500 of the $1.515 billion), and the fund sponsor firm is newly-formed and has a tiny workforce.
The firm’s start-up status raises interesting questions about why an institutional investor like CalPERS would make such a big bet that no other investors are making on a firm with no track record and virtually no investment management infrastructure.
You have also asked whether the CalPERS LongRange investment meets the criteria that CalPERS outlined for an investment to qualify as part of its “Pillar IV” strategy. The reason this matters is that after a lot of public attention, mostly generated by Naked Capitalism, the CalPERS board took binding legal action in 2019 to require that any “Pillar IV” investments be specifically approved by the board.
Despite this requirement, according to CalPERS documents, the commitment to LongRange was made without board approval, even though the fund’s strategy and structural attributes strongly parallel the description of “Pillar IV” that CalPERS previously outlined. This raises serious governance questions at CalPERS and even legal questions about the validity of the CalPERS contract with LongRange.
What follows is a summary of information and speculative conclusions based on a fairly extensive set of publicly-available data.
When looking at a new firm, it’s worth spending some time on the firm’s “origin story.” The main facts about that story that we know is that the Firm was founded very recently by Bob Berlin, and until just a few days ago, consisted only of him. The founding appears essentially coincident in time with when negotiations with CalPERS would likely have commenced in late 2019 or early 2020. Prior to then, Berlin was essentially unemployed, having jumped ship in April 2019 from a semi-anonymous partner-level role at Baupost Parters to an early partner role at Navab Capital, only to see that firm’s founding partner, Alex Navab die unexpectedly a few months later in July. At the time of its founder’s death, Navab was still in its start-up phase, leading to the firm being essentially still-born and immediately moving into a wind-down phase.
It’s important to note that at the time Berlin’s professional life was thrown into turmoil in July 2019, due certainly to no fault of his own, he was by no means a leading light of the private equity industry. He had worked for ten years at Baupost Partners, one of the most respected hedge funds, where his domain, private equity, was a sideline within a hedge fund firm. Also, Berlin apparently did not even run that portfolio within Baupost; he was a subordinate to someone else who did.
Prior to Baupost, Berlin got his start in private equity at JH Whitney, a once-staid private equity shop that has lost significant altitude since Berlin first joined it. One senses a certain scrappiness in Berlin’s career pursuits, as he possesses only a bachelor’s degree from Washington & Lee University and no MBA or other advanced degree. Baupost, by contrast, was founded by a group of Harvard Business School professors and tends to subscribe to the academic credentialism one can imagine being associated with a Boston hedge fund (Seth Klarman, its billionaire CEO, was a Baker Scholar at Harvard Business School). Like Klarman, who has been a major backer of Republican candidates, Berlin has given to Republican presidential candidates like Marco Rubio and Carly Fiorina.
Without more disclosure, it’s impossible to know how Berlin and CalPERS got connected. As part of its “Pillar IV” strategy, CalPERS was reported in the PE trade press as on the prowl for private equity start-up teams to back. The flurry of publicity around this occurred just prior to when Berlin’s partner died and he became unemployed, so it’s possible Berlin saw the press reports and sought out CalPERS proactively.
A more likely possibility, in my opinion, is that he started talking to people about creating his own shop, perhaps with more modest ambitions to raise $300-500 million (which is what he could have reasonably hoped for absent CalPERS), and someone he talked to had close ties to CalPERS and offered to walk him in. I base this speculation on having seen this type of scenario play out this way multiple times in my career, where someone enters the market with modest, realistic expectations for a first fund and stumbles across a pocket of capital with grandiose ambitions to shovel money out the door to untested firms. But, again, we don’t know.
One discrepancy about LongRange’s origins is exactly when it was founded. The firm’s website says it “was formed in 2019 by Bob Berlin,” while the firm’s ADV disclosure statement filed with the SEC says that “The Adviser [LONGRANGE CAPITAL, L.P.] has been in business since May 2020.” This jibes with the firm’s partnership registration in Delaware, which shows a formation date of May 1, 2020.
In my experience, it’s quite common for new investment firms to play fast-and-loose with their inception date story, wanting in some circumstances to place it further back in time in order to emphasize that they weren’t (literally) born yesterday, and in other circumstances to make it appear that money is flooding into them without them having spent any time fundraising. Berlin is almost certainly engaged in the former practice with his earlier website inception claim.
Speaking of entity formation issues and the LongRange website, it’s weird that the copyright for the website is held not by the firm parent but by a different legal entity, which is LongRange Capital LLC. This entity does not exist in Delaware, unlike the other LongRange entities. Almost always, when a private equity LLC does not exist in Delaware, it exists as a Cayman Islands entity, but that’s not the case here. If I were CalPERS, participating in the economics of the firm (which we’ll get to), I’d want to know more about this to make sure that the books aren’t being manipulated somehow via entities in obscure secrecy jurisdictions.
Before we get to the terms of CalPERS’ investment, I want to raise one other clear discrepancy. In its response question 23A on Part One of the LongRange ADV, the firm answered “NO” in response to a question whether the “fund’s financial statements [are] subject to an annual audit.” This response is almost certainly incorrect, as it seems inconceivable that CalPERS would have agreed to this, and LongRange may have offered an incorrect response in order to avoid the requirement, which the ADV form plainly states, that an amended ADV must be filed as soon as the audit is issued if there is an audit requirement.
Regarding the CalPERS Fund terms, we can learn an unusually large amount about them from a close reading of the LongRange ADV, as there doesn’t exist the usual problem of a manager describing different terms that apply to disparate vehicles and not knowing which terms apply to which vehicles. LongRange has only one fund at the moment, a fact which the ADV itself states, and it’s the CalPERS Fund, so any deal terms described in the ADV apply to the CalPERS investment.
Looking at the terms, the main take-away is that CalPERS did surprisingly little to throw away the dysfunctional, fraud-prone rule book governing business relations between private equity managers and their investors, and instead negotiated what could be considered a pro-investor deal as measured within that narrow framework.
The centerpiece of this deal, which I am sure the CalPERS management will privately crow about is a “budgeted management fee.” This concept, which has existed for decades in the investment management business, means that there is no contractually fixed management fee, which is almost always a significant source of profit for the manager. Instead, the manager is supposed to show its actual, budgeted costs for “keeping the lights on” and no more, and the investor pays only that, which supposedly keeps the manager focused on earning the lion’s share of its income via carried interest participation in fund profits.
Accepting the budgeted management fee concept immediately brings one to the next question: what is a reasonable budget? At the moment, LongRange, according to its ADV, has only three employees, Berlin, and two hires announced just in the last week. One is a CFO, so not an investment person but instead someone to keep the firm’s books. The other is a “senior principal” investment professional, meaning not a partner-level person but a guy who appears to be in his late 30s (having graduated from Columbia as an undergraduate in 2003). I would put the CFO’s salary/bonus at $500K. Market rate for the “senior principal” is probably $1.5 million. You can see that the numbers for these two people are already well past “keeping the lights on” if it is indeed what they are being paid.
Then there is the question of what Berlin should be paid. He was an unemployed guy before CalPERS found him and now owns a private equity firm with $1.5 billion of assets. Arguably, CalPERS should have been able to drive a hard bargain to keep his pay below that of his senior principal, at say $750K. So that brings the total current payroll to $2.75 million. That’s less than a 0.2 percent management fee expense for salaries at the current staffing level. Ramping that up to a 10 person investment staff, with a mix of junior and more senior people, would triple that.
What other operating expenses does LongRange have to cover? A lot less than you might think. According to the ADV, they consist solely of:
…compliance and regulatory costs, rent, utilities, office supplies, office equipment, the hiring, compensation and expenses of certain of its partners, officers and employees (other than Carried Interest described in Item 6 below), Directors and Officer’s, business and similar forms of insurance, retreats and “holiday” parties, and other normal and routine administrative expenses relating to the services and facilities provided by the Adviser to the Funds. For the avoidance of doubt, certain expenses identified in a Fund’s Organizational Documents that are borne by the Adviser will be borne out of Adviser proceeds other than the receipt of Management Fees, including, but not limited to, retreats and “holiday” parties.
Apparently, CalPERS’ position that it isn’t paying for LongRange retreats and holiday parties was very important to them, since LongRange repeats it twice here. But you can see from this disclosure statement that the only other major expenses that LongRange has to cover are rent and insurance. The firm is based in Stamford, CT, not exactly a high rent district, so these expenses taken together are unlikely to be more than a couple of hundred thousand dollars, bringing the initial build-out of the firm in at under 0.6 percent in terms of operating cost annually.
Even with padding, CalPERS should not be paying more than 0.7% as a budgeted management fee, especially in light of the fact that LongRange clearly views the CalPERS fund as a “first wife” to be later traded up for someone better, a perspective evident in the CalPERS Fund’s legal name of “LONGRANGE CAPITAL FUND I, L.P.” Once LongRange moves on to “Fund II” and later funds with non-CalPERS investors, its management fee stream will explode in step with whatever greater staffing aspirations the firm may have.
What about all the other expenses involved in running a business and an investment fund, costs like travel, legal expenses, auditors, consultants, etc.? The LongRange ADV makes clear that these expenses are all to be charged to CalPERS (and someday to other funds it may manage). Again, this is par for the course in private equity. A large portion of people with responsibility over private equity investments at pension funds don’t understand this, but they almost always pay for EVERYTHING other than what LongRange carved out—salaries, rent, and insurance, and sometimes the investors even pay those.
This is an example of how CalPERS failed to blow up the broken model of private equity in striking its deal with LongRange. Instead, CalPERS just fought for symbolic wins along the lines of, “We’re not paying for your winter Palm Beach five day firm ‘retreat’ (golf outing).”
Sadly, CalPERS doesn’t seem to realize that LongRange has given itself the same mechanism to charge CalPERS for a retreat/golf outing that a large portion of private equity firms use, which is simply to re-label the outings. The LongRange ADV states that CalPERS bears the cost of “business development meetings and/or events (with portfolio company management, customers, clients, borrowers, brokers and service providers)…” So charging the winter Palm Beach “retreat” to the fund is kosher, so long as LongRange engages in the standard industry practice of inviting the portfolio company CEOs and some investment bankers, and scheduling a few meetings with them on the hotel veranda over brandy and cigars (also paid for by the fund).
The LongRange ADV identifies other purely symbolic concessions to CalPERS, such as cutting CalPERS in on management fees and carried interest paid by co-investors. However, co-investors very rarely pay either management fees or carried interest, so this is a Potemkin win for CalPERS.
The one significant win, on the other hand, that it does appear that CalPERS did get is the right to receive a portion of management fees earned by LongRange from other investors. Again, I view this as in some ways disappointing, as it’s a clear statement that CalPERS wants to see LongRange join the club of overpriced management fees, so long as CalPERS is cut in on it. Why CalPERS does not see this as a genie that will eventually escape the bottle and be turned on CalPERS in future funds is beyond me.
One last point, before turning to the question of whether this LongRange deal exceeded CalPERS management’s authority, is that the LongRange ADV makes clear that LongRange expects to be reimbursed from portfolio companies for many expenses, which could include expenses not eligible to be reimbursed by the Fund. This is one of the most dangerous practices in private equity, which is nearly universal in the buyout space but which allows theoretically egregious billing practices for sham expense reimbursements (e.g., Call in portfolio company management for a regular update meeting, then charge them thousands of dollars for use of your conference room. Rinse and repeat dozens of times a year).
Again, CalPERS had the opportunity to prohibit this practice, but didn’t, and even the reporting that LongRange appears to have committed to about what reimbursements it receives from portfolio companies doesn’t inspire confidence, as it seems to suggest that whatever reports are made are at the discretion of LongRange and also that the only payments that will be reported are ones that are credited as “Offset Fees,” as opposed to reimbursements which are not “Offset Fees” and, it seems to imply, therefore will not be reported:
From time to time, the Adviser will, to the extent required under the Fund’s Organizational Documents or otherwise, in its discretion, disclose to an investor the amount of Offset Fees allocated to the Fund in which such investor has invested in account statements or other similar periodic reports delivered to investors.
Finally, to address the issue of whether this LongRange deal should be understood as an implementation of the “Pillar IV” strategy, in my opinion, there is no doubt that it is. CalPERS publicly described “Pillar IV” of its private equity strategy as having several key attributes, consisting of:
1) Investments expected to be held for an indefinite, long-term period;
2) Manager teams that are put into business by CalPERS to implement the strategy;
3) A budgeted management fee structure to avoid having returns that are expected to be lower than traditional buyouts not overly burdened by costs.
Regarding point one, the indefinite holding period, LongRange itself has defined its strategy this way: “LongRange plans to back businesses without reference to a fixed term as a way of optimizing value, its spokesperson told Buyouts.”
Naked Capitalism itself quoted CalPERS management about point two, the building of new teams for the strategy in a March 2019 post.
Regarding point three, Ben Meng talked about the budgeted management fee as a key component of the Pillar IV strategy at the March 18, 2019 Investment Committee meeting, where he said:
….reduced cost is embedded in the structure of these new vehicles, namely, we are adopting a pre-approved budget approach as opposed to paying a fixed management fee.
Why does this matter—why is it significant that CalPERS has moved forward to implement its “Pillar IV” private equity strategy? The reason is that CalPERS has publicly reported that the investment commitment to LongRange was made pursuant to “delegated authority” of CalPERS management, where that authority was delegated by the CalPERS board.
However, when the CalPERS board last publicly engaged the question of moving forward with Pillar IV, in March 2019, State Treasurer Fiona Ma made an amendment to the motion authorizing CalPERS to move forward, which was voted on and enacted, where the motion specifically denied CalPERS management the authority to complete any Pillar IV investments without a further vote of the board. Here is how Ma summarized her motion amendment:
We are not committing any retirement funds to a general partner at this time. And that after implementation and funding plan is established, you will come back and get another vote by this Committee before moving forward.
Again, this motion was adopted by the board after extensive discussion by the board and management, where management devoted significant time to pretending a pearl-clutching shock that the board would distrust it so much as to feel such a motion necessary. I’m not a lawyer, but it seems to me that the specific revocation of the CalPERS staff’s authority to complete any “Pillar IV” investment under delegated authority makes any Pillar IV investment contract invalid, since the staff lacked legal authority to enter into it.
So I hope this analysis is helpful to you and your readers. LongRange is in some ways a strange private equity deal and at the same time one that is all too ordinary.