CalPERS Cooks the Books While Taking an Unnecessary Loss to Exit $6 Billion of Private Equity Positions

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CalPERS is up to its old crooked, value-destroying ways. Its sale of $6 billion in private equity positions, at a big discount….because CalPERS was in a hurry despite no basis for urgency, shows yet again the sort of thing the giant fund routinely does that puts it at the very bottom of financial returns for major public pension funds.

Oh, and on top of that, CalPERS admitted to Bloomberg that it is lying in its financial reports for the fiscal year just ended this June 30 by not writing down these private equity assets. As former board member Margaret Brown stated:

In Dawm Lim’s Bloomberg story, Calpers Unloads Record $6 Billion of Private Equity at Discount, CalPERS admits to cooking the books. Not recognizing the sale (the loss in value) in the same fiscal year can only be to play shenanigans with the rate of return. So if, or more likely when, CalPERS again does badly in comparison to CalSTRS and similar funds, remember it would be even worse if CalPERS was accounting honestly.

CalPERS admits it took a hit for unloading such a big interest in a rush. From the story:

The California Public Employees’ Retirement System sold about $6 billion of its stakes in private equity funds to second-hand buyers, severing ties with a slew of past managers and freeing up cash for new wagers.

The $440 billion public pension fund, the largest in the US, has cycled through four investment chiefs since 2009 and has long wrestled with the complexity of its $50 billion in private equity holdings. Calpers hired Jefferies Financial Group Inc. to explore ways to clean up its portfolio and shop a swath of assets, according to people familiar with the matter….

the deal is not only the largest of its kind by Calpers, but private equity executives said it’s probably the biggest-ever involving second-hand fund stakes changing hands.

Trading in such size came at a price: Calpers sold its holdings at a roughly 10% discount to their value in September 2021, some of the people said….

The blockbuster transaction generates money for investment chief Nicole Musicco, who took over earlier this year, to make new wagers as markets remain volatile. She has told Calpers directors that she wants to build a team that would buy stakes in private companies. That would let Calpers gain more control and bypass private equity firms like Blackstone Inc. or Carlyle Group Inc.

The Bloomberg article also shows CalPERS making nonsensical justification for this move. First, CalPERS just increased it allocation to private equity from 8% to 13%. There is simply no way Musicco has made commitments for all this extra dough; in fact, it would be incompetent to do so. You don’t want to make a huge number of investments in one year, like an anaconda swallowing a rabbit. On top of that, she admits that she hasn’t even hired the staffers she needs to implement her chosen strategy. That even more strongly argues against haste in deploying funds.

The article in fact does say that CalPERS is deferring some of the sales proceeds, but that still does not justify unloading such a big stake at once that it was guaranteed to result in poor prices. As the article explains further down:

The haircuts for various assets sold by Calpers range from high single-digit percentages to about 20%, some of the people said.

In a move to make any discount less punitive, Calpers opted to defer some payments beyond June 30, the last day of its fiscal year, people said. That allows Calpers to continue collecting some of the cash generated by the investments. And by not taking all of the sale proceeds upfront, Calpers can avoid a large balance of undeployed cash, which would drag down performance for the latest fiscal year.

The article points out that 2021 “secondary” sales were the highest ever, at $63 billion. CalPERS was obviously offering a market-choking amount. And given the Fed’s commitment to killing the economy, um, inflation with higher interest rates, when the Fed can’t solve Covid-induced supply shortages or Russia sanctions blowback, private equity is not a good place to be. Even the Economist is warning Private equity may be heading for a fall. There’s every reason to think that secondary sales will be down this year. Bloomberg confirms that suspicion: “Wall Street is bracing for a slowdown in trading private equity stakes. With markets in flux, some sellers are hesitant about striking deals at steep discounts.”

Yet CalPERS decided to unload what was unquestionably such a large total amount that it could only be handed at a serious discount. So Musicco has admitted she violated her fiduciary duty by taking action that resulted in a totally unnecessary loss. Even newbies in finance know you never dump big positions unless you are desperate. If you have a large holding you intend to sell, but you aren’t under time pressure to do so, you do so in dribs and drabs. Why didn’t CalPERS sell $1 billion every six months rather than dump such an oversized amount? Even worse, CalPERS paid Jeffries & Co for this “advice”.

To put it another way, these excessive “discounts” amounted to a gift of funds to the buyers, Franklin Templeton subsidiary Lexington Partners and CVC Capital Partners’ Glendower Capital. But the organizations are professional fund managers; they can’t do favors for CalPERS (unlike, say a law firm that might give free advice or a fee discount). So one then wonders if these gifts weren’t intended to procure personal favors, particularly since disgraced former Chief Investment Officer Ben Meng and former head of ESG, Ann Simpson, left CalPERS for Franklin Templeton.

As one prominent CalPERS retiree observed:

Besides, it’s not “corruption,” when it’s a “relationship.” Just ask Marcie.

BTW, I just love that Dawn Lim refers to CalPERS’ private equity investments as “wagers.” Ain’t that the truth. So much for the Business Judgment Rule…

Second, the article takes up the bizarre allegation that CalPERS has made for years, starting with former Chief Investment Officer Ted Elioupoulos, that CalPERS’ private equity portfolio is somehow too big and messy. It’s just so hard to keep on top of all those stakes!

Gee, CalPERS has the biggest investment office of any public pension fund. And it’s not as if difficulty rises geometrically with the number of deals.

So this amount to an admission that the private equity team is incompetent.

You’ll note that the implication is that “big and messy” hurts returns. In fact, CalPERS did better in private equity before it started attempting to streamline. Remember, fewer deals means on average bigger sized deals. Eliopoulos explicitly set out to reduce the number of managers that CalPERS invested with and to focus on the really big fund managers like Blackstone and Carlyle so CalPERS could make correspondingly large investments.

The problem is that the big deals are overwhelmingly leveraged buyouts. CalPERS own consultant reported back after Eloupoulos’ great simplification exercise that it had hurt returns because the LBOs delivered the worst results within private equity. Those “Oh so hard because investing in smaller deals is more work! Why should I work?” growth-y managers and transactions were more lucrative. The consultant’s work has been repeatedly confirmed by Pitchbook reports and by the findings of private equity experts Eileen Appelbaum and Rosemary Batt.

But Musicco is intent on doubling down on failure, apparently because it suits her and CalPERS’ ego to run with the big dogs. And just like Ukraine, it doesn’t matter if you are losing if you’ve convinced yourself you can manage the PR. But we can see with Ukraine that reality eventually prevails. How long can CalPERS keep up its mirage?

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  1. kriptid

    Relevant article in the WSJ a couple of weeks ago, not sure if this made it into the Links at the time. Long and well worth a read:

    Pension Funds Plunge Into Riskier Bets—Just as Markets Are Struggling

    Relevant passage:

    The Teacher Retirement System of Texas, the U.S.’s fifth-largest public pension fund, began leveraging its investment portfolio in 2019. Next month, the largest U.S. public-worker fund, the roughly $440 billion California Public Employees’ Retirement System, known as Calpers, will add leverage for the first time in its 90-year history.

    While most pension funds still avoid investing borrowed money, the use of leverage is spreading faster than ever. Just four years ago, none of the five largest pension funds used leverage.

    I imagine this is prelude to a larger trend.

    It seems there are two possible outcomes. The envisioned outcome is that taking on leverage helps CalPERS et al. fulfill future obligations. The other possibility is that it only deepens the hole which many pension funds have been intent on digging themselves into.

    Based on their recent performance, I know which outcome I’d place my bets on. Of course, I’m sure fellow market participants are excited about CalPERS taking 5-10% (just for starters) leverage on $440 billion and spreading it around its existing investment portfolio. Everyone else has a chance to sell the pump while the public employees of California assume further risk.

    1. Susan the other

      I sense a sea change. Maybe 2 weeks ago I read a blurb (poss I heard it on PBS) that the Biden Adm was organizing the BBB plan to eliminate excess CO2 and create a new economy. Can’t remember much about the news item except it also mentioned that the gov plans to fund all this with PPPs; private investors, PE funds, and “retirement funds.” Sounds like a financial mobilization to end all finance. So if CalPERS is smart they are looking for a sweet government deal, no? Without a middleman. Something that even allows leveraged investment as well as investing the money earmarked for “beneficiaries” – with a contract that insures a certain return. How else can the Federal Gov entice money from honest fiduciaries? So it would definitely be a better deal than hanging on to Private Equity funds that have run out of opportunistic investments because their business model is simply no longer viable. Vultures need a steady diet of road kill and all the bunnies are gone. This all sounds like the BBB behemoth emerging. I could be a good thing. A much better project than pouring money into that other thing euphemistically called “Ukraine.”

  2. The Rev Kev

    ‘Even newbies in finance know you never dump big positions unless you are desperate.’

    Geez, even I know that you don’t do stuff like that but slowly feed that stuff back into the market. But when I think about it, are they actually desperate? I mean, they took a big hit when they were forced to dump all their investments in Russia a coupla months ago though I bet that those investments would have been going very well by now, thank you very much. So does CaLPERS have liquidity problems right now or foresee some coming up? It might explain this sudden dump in bets, err, wagers, err positions. Even the Board of CalPERS can see that the market is already going sideways and in fact now might be a good time to make a graceful exit, stage right.

    But the way that they handle investment reminds me of a film I saw a long time ago where this young guy came home after graduating from high school as he was ready to go to college but the parents told him that they were using those college fund investments to buy themselves a swimming pool instead – which he would be able to use. And that the leftover funds will give those parents a nice boat cruse as well. Still, if Sacramento is happy to let this state of affairs to continue, who am I to disagree? They have just announced that they will have a $100 billion budget surplus so I guess that they can afford to bail out CalPERS when the time comes.

    1. David in Santa Cruz

      I smell capital calls.

      Disgraced ex-CIO Yu “Ben” Meng (ironically now at the Franklin Barber Shop where CalPERS gets its haircuts) had his hair on fire to make billions in commitments to his friends at Blackstone within 90 days of getting off the plane from Beijing (conflicts and cover-up still under investigation by the California Fair Political Practices Commission). Blackstone gathered huge commitments at that time but made few deals. With markets down, they’re probably sniffing under the table for distressed companies to take private.

      As I have come to understand it, this is the other problem when public pension funds invest in PE — capital calls by their very nature come at the worst possible time to have to liquidate assets in order to come up with the cash…

      1. flora

        Didn’t Meng drop a hedge position that ended up costing CalPERS big bucks when the main investment it was hedging went pear shaped?

  3. shinola

    This is one long, sad tale. Seems like I’ve been reading about the incompetence, mismanagement (and/or corruption) at calpers ever since I became a regular reader of NC years ago. It just never seems to end…

  4. flora

    Welp, CalPERS is so consistently one way (down) in its economic trades I’m starting to think there’s a plan. (Not joking.)

    Former CA Atty. General X.Becerra won’t be all over this one, though. He’s in the B. admin now. (Like Kamala, his predecessor as CA AG.)

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

  5. Samuel Conner

    Perhaps there’s money to made selling insulin to diabetics, at a markup that is a bit lower than the current very high markups.

    Just an idea. They can start an in-house PE group. Why not an in-house pharma manufactory? They’ve got plenty of funds, and there may be public-spirited process engineers who are either recently retired or would like to work for people who aren’t sociopaths.

    Oh, … wait.

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