Given the resentment in many quarters of the US towards government employees, particularly those with decent pensions, you’d think cities and states would recognize that having them enjoy lavish, private-equity-paid travel was not only terrible optics but also smacks of corruption. But instead, the prevailing attitude seems to be that as long as the travel bills aren’t being paid directly by the government, the unseemly plushness of these junkets conveniently falls outside official travel policies.
A recent expose by the Philadelphia Inquirer does a fine job of documenting the extent and cost of private equity related travel by the investment team at the Pennsylvania School Employees Retirement System, or PSERS. The article makes clear that PSERS employees did not book these trips, nor did the pension system pay for them directly. These charges were made to the various private equity funds in which PSERS invests. While PSERS bore only a small fraction of the cost of this travel, it was also paying for other investors’ travel costs.
However, the significance isn’t just the lack of propriety of having state employees travel in a style well beyond normal state travel allowances, as well as what these workers would be able to pay personally. The trips to a large degree are unnecessary, save to advance the interests of the general partner, to the detriment of investors like PSERS.
These jaunts keep the private equity staff regularly in personal contact with the private equity firms, when as limited partners, they have zero say over investments (we’ll turn later to the role of the toothless-by-design “advisory committees”). These trips serve as marketing and relationship-building for the general partner coming out of the investors’ hides. They also keep public pension employees busy doing fake oversight at the expense of real oversight, which they can do better at their desks, reading the limited partnership agreements and the various documents from the fund managers to understand if they are complying or not.
PSERS disclosed its travel expenses…but its accounts would include only trips that paid for by PSERS. For private equity, the charges are nearly all ones later reimbursed by various private equity funds. However, they do not include travel booked and paid for by the private equity funds. So taxpayers have only a partial view. Fron the Inquirer:
For many years, the fund’s spending on travel has been secret to the public. Under pressure from reformers on the board, the pension plan produced its first breakdown of 2019 travel late last year. Reports for 2017 and 2018 were only made available in March.
The staffers in PSERS’ investment shop are paid somewhat like their counterparts in private high finance. James Grossman, the chief investment officer who has worked for PSERS for nearly 25 years, is the highest-paid employee in state government, making $485,000 yearly. His deputy is paid $399,000. The average salary in the unit is about $190,000.
Grossman and most of his staff are often on the road. Their most frequent destination has been New York, followed by London, then Boston. Philadelphia was the fourth most listed destination.
Itineraries have included Dublin, Edinburgh, Lisbon, Macau, Madrid, Saudi Arabia, Singapore, Seoul, and Stockholm. They have gone to meetings in such American hot spots as Beverly Hills, Orlando, and Park City, Utah, along with dozens of other U.S. cities.
In a microcosm of the sorry state of private equity fees and costs, where no private limited partner knows their true investment costs because many are hidden from by being charged to portfolio companies, rather than at the fund level, PSERS couldn’t be bothered to tally its travels cost. From the article:
At a PSERS meeting last spring, another board member, Nathan Mains, said regarding travel: “We really don’t have a sense of what some of our funds or managers or others have actually spent.”
Grossman replied: “That is correct.”
The Inquirer points out that there are many gaps because the general partners blew off PSERS’ information request:
[Spokesperson Steve] Esack had said earlier that “100% of vendors” had replied to queries about the trips. Asked about the hundreds of blank responses, he wrote Friday: “These are the records the managers provided.”
So we are to believe that private equity firms that are acting as stewards of hundreds of millions to billions of dollars don’t keep their books well enough to be able to substantiate travel charges? Esack’s lame comment shows the position that the limited partners have put themselves in: they’ve locked up their money and can’t even get adequate disclosure of how it is being spent. That produces results like:
Of the almost 500 trips, 80 have fares listed as zero, including four flights to London, as well as flights to Beijing, Hong Kong, and Zurich.
Even more trips had nothing listed for hotel costs. One was a trip that investment chief Grossman made in the summer of 2018 to Jeddah in Saudi Arabia. The report says his airfare was $7,015 but lists his hotel bill as zero.
The article points out that the PSERS investment office regularly violates state travel policies, which require employees on Commonwealth business to hew to Federal guidelines for airfare and lodging. Eight PSERS officers have been granted waivers from this policy.
PSERS defends the travel costs by saying staff traveled business class and the fares were typically refundable and sometimes bought at the last minute.
My issue isn’t with the cost of the flights but their necessity, and with the hotel costs. Public servants should be staying in Westin/Marriott level rooms. These prices are consistent with five star hotels, like the Four Seasons or St. Regis in New York City.
PSERS’ defense of the trips is absurd if you understand the role of limited partners. Here’s the agency’s justification:
“PSERS has been a global investor for decades,” its spokesperson, Steve Esack, said in a statement. “Its investment team must be willing to travel in order to properly perform their fiduciary duty of monitoring existing investments or conducting due diligence on prospective investments.”
“PSERS investment staff works during these flights to prepare for their meetings,” the statement also said. This sentence was underlined.
“Staff worked on the plane.” Come on. For starters, flights from the East Coast to Europe are almost always overnight. Are we supposed to believe they arrived bleary eyed and tried to function on no sleep?
But let’s unpack the more troubling but less obvious howler: that the travel is “to properly perform their fiduciary duty of monitoring existing investments or conducting due diligence on prospective investments.” Just because the staff may actually believe that does not make it so.
Bluntly: “What about ‘limited partner’ don’t you understand?” Limited partners contractually have absolutely no say about how private equity investments are made and managed and when they are sold. They are along for the ride. There’s no point in “monitoring” beyond reviewing investment returns. In fact, they are paying the general partners to do that! On top of the management fee, which is the compensation to the general partner to buy attractive businesses and oversee them, nearly all general partners double-dip by charging a “monitoring fee” directly to portfolio companies.1
But here’s a section that ought to trigger readers, but won’t:
The task before them is to check on fund investments. So, for instance, when Luke Jacobs, a PSERS private-equity manager, flew to London on March 4, 2019, for a round-trip fare of $13,025, he attended annual meetings for two funds of Apax Partners, called Apax Digital and Apax Europe VII. PSERS has put more than $300 million into the two Apax funds.
This is one of the two main types of meetings a limited partner like PSERS will attend. One is the annual meeting for the funds. These are incredibly lavish productions where the general partner has well-oiled talks about how great the fund is, as well as top-tier entertainment, with the very best food and wine you can serve in a conference setting. For instance, from a 2016 post:
Another routine form of private equity rent extraction is how they get the fund investors, who are fiduciaries, to pay for lavish annual conferences which for the biggest funds includes big ticket entertainment like Elton John:
— Doug Curling (@shakadoug) October 19, 2016
And for the still skeptical, another source has confirmed that Elton John performed at the TPG conference. And as is typical in limited partnership agreements, investors are on the hook for the costs of “meetings” and this show, as part of a limited partner event, was on their nickel.
The second type is the meeting of the advisory committee, which is subset of the limited partners, chosen by the general partner. This is a fig leaf to support the fiction that limited partners have some checks on the general partner. Certain matters, most importantly waivers of conflicts of interest, require the approval of the advisory committee.
However, the general partner, who controls who sits on the advisory committee, takes great care to include enough “friendlies” so as to assure that the general partner will never lose a vote (these are often respectable-seeming players like the JP Morgan private equity fund of fund. No fund of funds will ever cross a general partner; they need to preserve access to as many funds as possible).
Nevertheless, general partners also like to avoid controversy, since the “non friendlies” minority (who don’t even recognize that the advisory board is stacked) typically includes investors who have stature. Having them vote against the general partner on any more often than rarely not only means an influential investor might not participate in the next fund, but even worse, their opposition might become the talk of the next big industry conference.
What is the most economically significant matter that regularly comes up before advisory committees? Waiving the conflict of interest for the general partners to pay themselves M&A and financing fees. This amounts to double charging the portfolio companies, since the general partners engage investment bankers to do the work. You’ve probably seen psychological research that has found that a gift as minor as a can of soda will predispose the recipient to a request made by the giver. It psychologically would seem churlish to say no to general partners who’ve arranged for travel and accommodations that vastly more luxurious than what public employees are allowed or what these staffers could afford in their private lives.
Mind you, the limited partners are so
bought captured that they don’t even exploit the power of these extremely valuable transaction fee waivers, which are indefensible from a fiduciary duty perspective, to trade for better disclosure: “We’ll give you the waiver only if you and any agents and affiliates account fully for all the fees and costs you incur pursuant to this waiver.”
And the proof of the pudding is that the PSERS approach to monitoring has delivered remarkably sub-par investment performance:
The pension plan has invested heavily in private equity, betting on enterprises not available on the stock market. These deals have prompted criticism for high fees and middling performance. Fund reports show such investments lagging behind its U.S. stock buys for the last decade. Last year, its private-equity portfolio fell 4.2% in value while its public stocks rose 3.2%.
The pro-accountability board members are upset, and for the right reasons. Again from the Inquirer:
“It’s hard to imagine how any person, much less a state employee, hired to serve the public, is even permitted to spend more than $10,000 for airfare, or thousands of dollars in hotel costs for a single trip,” [State Senator Katie] Muth said in a statement
“But what’s more important here is that the Wall Street money managers flying investment office staff to Paris and Hong Kong are the same ones turning around and asking for huge, shady contracts to manage public money,” she said.
Now in fairness, PSERS has made co-investments, in which it invested along side a general partner but (typically) paid no or reduced management fees. The general partner most often offers the opportunity to investors in the fund, but it will sometimes solicit an outside investors for political reasons, such as CalPERS or CalSTRS because the business has California regulatory issues.
However, it seems very unlikely that any controversial high-cost trips would have involved co-investments. First, a PSERS does not have employees that know how to do due diligence on companies. So even if they were to visit the offices of a potential investment, they wouldn’t know how to conduct an inquiry.
Second, PSERS would not tag along with a general partner while it was doing due diligence. The average middle market company gets dozens of bids. There would be no assurance that the general partner would wind up the buyer.2
Third, PSERS made only small co-investments. In 2019, through mid December, the agency had committed $1.47 billion to 2019 “vintage” funds, while as through mid October, it had made $153 million in co-investments, of an average size of $19 million. Even if you take this run rate and project it through mid December, you get $185 million in co-investments. Not shabby, but also not worth incurring much if any travel costs since staff doesn’t know what questions to ask.
Some contacts in private equity say the Inquirer piece has rattled quite a few funds. Let’s hope so. Even though this is far from the biggest transparency failing in private equity, it’s one people understand. You pry the door open where you find a crack.
1 Oxford professor Ludovic Phalippou, who has read many monitoring agreements, calls them “money for nothing.” From a 2014 post:
The wee problem is that when you look at these agreements, it’s clear no business would enter into this arrangement. While the portfolio company has an unambiguous obligation to make payments to the private equity firm, the private equity firm is under no obligation to do anything to justify getting these fees. I’m not making this up, as this highly engaging video called “Money for Nothing” by Professor Ludovic Phalippou of Oxford attests. The entire video is worth watching, and the critical section starts at 8:00
Here is his translation of the services agreement:
I may do some work from time to time
I do some work, only if I feel like it. Subjective translation: I won’t do anything.
I’ll get [in this case] at least $30 million a year irrespective of how much I decide to work. Subjective translation: I won’t do anything and get $30 million a year for it.
If I do decide to do something, I’ll charge you extra
I can stop charging when I get out (or not), but if I do I get all the money I was supposed to receive from that point up until 2018.