CalPERS Retiree Group Launches GoFundMe for Investigation on Private Equity Fees

We started writing about private equity fees in 2014, with CalPERS as a major focus. That is not simply because CalPERS, as the biggest public pension fund, has long been seen as a standard setter. For instance, its decision in 2014 to abandon investing in hedge funds rocked the investment world. But with private equity, CalPERS has not only remain doggedly loyal to private equity but is even increasing its commitments as other investors are exiting the strategy by reducing commitments and even selling current stakes at a discount.

If you are a CalPERS beneficiary or California taxpayer, please go straight to the GoFundMe page and support this campaign. Remember that CalPERS investments are ultimately backed by the state, so citizens are on the hook for any pension shortfalls.

From the top of the GoFundMe page:

In an era when public trust in government institutions is increasingly fragile, transparency and accountability are more essential than ever. Nowhere is this truer than in the management of public pensions. The financial lifeline for millions of retirees who depend on their pensions not only for dignity in retirement but for economic survival.

For California’s retired public employees, CalPERS (the California Public Employees’ Retirement System) is the single most influential entity determining that future.

But over the past decade, a growing chorus of stakeholders — retirees, watchdogs, financial experts, taxpayers, and even some legislators — have raised serious concerns about the transparency, governance, and investment practices of CalPERS. Questions have surfaced around its private equity deals, fees, underperformance relative to risk, conflicts of interests, and governance structure. These concerns are too important to ignore.

It’s time for the Retired Public Employees’ Association of California (RPEA) to step up and act decisively by crowdfunding an independent investigation into CalPERS. This is not just a prudent move, it’s a necessary one.

Also keep in mind that that the status of CalPERS pensions as ultimately governments obligation means Californians can also bear extra costs due to ratings agencies downgrading the state over pension underfunding.

We’ll soon turn to a new NBC News story by Gretchen Morgenson about this initiative, which demonstrates its importance.

The persistence of myths about private equity performance, and the success in hiding how much private equity firms rake off at investor and investee company expense, depends critically on the extreme secrecy regime that private equity firms have imposed and for the most part, successfully defended. Unlike every other type of contract, including other investment agreements, private equity contracts and many other basic details, like what companies particular funds invested in, are shielded from public scrutiny via either state law or attorney general opinions.

To give one example: as this CalPERS retiree initiative demonstrates, no one knows how much private equity investors (“limited partners”) pay in fees and costs. This is despite the foundational requirement that fiduciaries like public pension funds evaluate fees and costs as part of their fiduciary duty in making investment decisions.

CalPERS bizarre behavior persists despite more and more mainstream outlets confirming what we have discussed for years, that private equity does not outperform public stocks. For instance, from the Financial Times earlier this month in Private market funds lag US stocks over short and long term:

The data shows that the S&P 500 outshone private markets funds for the last three months of 2024, as well as on a one, three, five and 10-year basis. That marks the first calendar year that private markets funds have underperformed the stocks index across all measured time horizons since 2000.

The gap in performance last year between the two indices was also one of the largest on record.

The underperformance comes after investors globally have poured trillions of dollars into private markets, betting that they can provide higher and less volatile returns and access to more companies than equity markets.

Mind you, this underperformance is far worse than it seems. Higher risk strategies are supposed to deliver more expected returns than lower-risk ones. Historically, investors have set benchmarks positing that private equity needs to out-perform public stocks by at least 300 basis points (3%) to compensate for its additional risks of leverage and lack of liquidity. No wonder most investors are looking for a way out.

On top of that, one of the other long-standing justifications of private equity, that it helps diversify a portfolio (in finance-speak, it does not co-vary all that much with public stocks) is strictly a function of bad accounting. While other investment strategies report results as of the end of the measurement period (nearly always monthly), private equity funds report quarterly and nearly always with a one quarter lag. Yet endowments and pension funds, with the advice of supposedly top professionals like Wilshire, treat the returns as if they happened as of the lagged date, as opposed to correcting back to the end of the measurement period. Correcting for this error results in private equity performance being highly correlated with stock market results, as in providing no diversification benefit.

The sick part of this picture is that private equity could potentially offer decent risk adjusted returns to investors if the private equity fund managers weren’t so grotesquely greedy. CalPERS in 2015 estimated that the total fees and costs of private equity were 7% per year. That is a simply stunning level. Anyone who is even mildly finance-savvy knows that investment costs come at the expense of performance.

We’ve written many many post on the ways private equity fund manager hoover money out of the funds in ways that are invisible to the limited partners or hard to measure properly. A simple one is abusive charges made to the investee companies. None of the private equity fees charged to the portfolio companies are disclosed to the limited partners.

And “abusive” is no exaggeration. We turn the mike over to Oxford Business School Professor Ludovic Phalippou, who describes “monitoring fees” as “money for doing nothing.” This entertaining video (worth watching in full) is about a decade old, yet perilous little has changed. 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.

To continue this sorry tale, CalPERS, which has far and away the biggest invesstment office of any public pension fund, is also a stand out underperformer even relative to other public pension funds. Quant maven Richard Ennis determined in a 2021 study that CalPERS was a standout in generating “negative alpha”, which is investment-speak for destroying value. From our writeup, CalPERS Comes Dead Last of 34 Public Pension Returns Despite Having Biggest, Best Paid Investment Office:

The best thing CalPERS could do would be to fire virtually everyone in its investment office except for, say, those who run in-house index funds, slimmed down private equity and real estate teams to manage what would become legacy portfolios, and a few people at most to work on asset allocation. The rest of the money would go to a simple allocation strategy invested in Vanguard or equivalent index funds. A project sponsored by Stanford to look at alternative approaches to managing public pension funds found that a simple five-fund Vanguard strategy beat the results of 90% of public pensions funds. That finding continues to hold.

Now we will turn to Morgenson, who shows that CalPERS’ poor performance persists:

Retirement anxiety is a nationwide worry, of course, and it looms large for CalPERS’ 2.3 million members. CalPERS’ obligations to beneficiaries are only 75% funded, its latest financial statements show, below the national average of 83.1%, according to the National Conference on Public Employee Retirement Systems.

CalPERS’ investments have lagged behind other pensions’ — its portfolio of stocks, bonds, real estate and private equity returned 6.6% on average in each of the past five years, against the average public fund’s gain of 7.15%, according to NCPERS. Last year was a bit better, with CalPERS up 9.3% versus the average public pension fund return of 9.47%. Still, CalPERS’ one-year gain lagged behind its benchmark return of 10.3%.

Although publicly traded stocks have been among CalPERS’ best performing assets of late, the fund has increased its exposure to costly and opaque private investments, including private equity.

75% funded is a terrible figure in this richly priced investment environment.

Morgenson details how CalPERS is doubling down on its loser private equity strategy:

The most recent annual financial report shows CalPERS had 15.6% of its portfolio in private equity, up from its previous target weight of 10% in 2023. Measured over one-year, five-year, 10-year and 20-year periods, CalPERS’ private equity has underperformed its benchmark in three of those time frames, its records show.

This result is even worse than the bare facts suggest. We have chronicled over the years how CalPERS had diddled with its private equity benchmark, lowering its premium against stocks from 300 basis points to 150, and choosing more flattering (as in lower performing) stock indices.

Super-sized fees and costs are obviously a huge drag on results, yet CalPERS board members over the years have blow off their fiduciary duties and show more loyalty to private equity than to their beneficiaries. CalPERS is being a bit more careful with an investigation looming; they got a stooge to act as their messenger. From Morgenson:

At [CalPERS’ spokesperson] Scullary’s suggestion, NBC News raised [former board members Margaret] Brown’s and [JJ] Jelincic’s concerns with Rocco Paternoster, executive director of California State Retirees, a 44,000-member advocacy group advocating for retired state employees on their pension and health benefits. Paternoster characterized Brown and Jelincic as disgruntled former CalPERS board members and said that while his members would like the funding level to be higher than the current 75%, it “is not something we’re panicked about.”

Asked about CalPERS’ increased commitments to costly private equity partnerships, Paternoster said, “We believe you need to incentivize people to work hard on your behalf. Commissions and fees are not a concern for us.”

Needless to say, the ad hominem attacks demonstrate an inability to defend what CalPERS is up to on the merits. Contrast Paternoster’s handwave with the damage done to pensioners and potentially taxpayers:

CalPERS records show it paid private equity managers $569 million in investment fees in its most recent fiscal year, just over half of the total $1 billion the fund paid in fees to manage its investments.

Again, the fees that the private equity firms, in their munificence, ‘fess up to, is only a portion of total fees and expenses. Many are sucked directly out of the investee companies and not disclosed to the likes of CalPERS.

And as we documented above, there’s no need to “incentivize” these private equity locusts. CalPERS would do better by shutting down its entire alternative investments program.

The much-maligned JJ Jelincic points out that despite increased media interest, the private equity secrecy regime has gotten worse:

J.J. Jelincic, another ex-CalPERS board member who is now director of health benefits at the Retired Public Employees’ Association, is especially concerned about a lack of transparency in the pension fund’s operations.

“They are getting more and more secretive, and that clearly is upsetting,” he said. “It’s getting harder and harder to know what they’re up to.”

Brown also weighed in:

“Does anyone honestly believe that CalPERS knows more than the major investors around the world?” Brown asked. “Or is CalPERS simply betting that private equity will save the pension fund and bolster returns? I believe the latter.”

Similarly:

“I seriously feel my pension is at risk,” said David Soares, a former prosecutor in the San Francisco Bay area who retired in 2016 after 32 years on the job. “What we’re seeing is an absolute wholesale looting of the fund through fees being paid to outside managers. They are letting billions of dollars fly out the door with no benefit.”

But there are signs of more than mere cognitive capture at work at the board. Recall how SEIU organized aggressively and deployed hundreds of thousands of dollars to back potted-plant board candidates to defeat pro-transparency reformers Brown and Jelincic. Why more generally would unions be so eager to defend investing in private equity? This is, to paraphrase Lenin, selling the unions the rope with which they are being hung. The successful war against labor bargaining power, in which private equity has played a leading role, has generated entirely understandable resentment among many workers and taxpayers of the now-relatively-privileged status of government employees, with the budgetary drain of public pensions fund commitments increasingly serving as a bloody flag.

One beneficiary gave a tangible example of corruption:

The “Dark Money”-funded Astroturf outfits that elected SEIU-backed CalPERS board candidates to the Retiree and At-Large seats were run by SEIU political director Terry Brennend’s son Scott. That was laundered through his Brennand and Associates lobbying firm — all registered to Terry Brennand’s home address. It’s not just defending against a pension privatization ballot battle, it’s nest-feathering.

To put this another way, critics of private equity grifting are falsely branded as attacking public pension funds, as opposed to preventing their looting. Other insiders speculate that there are more corrupt wink-and-nod understandings, like the private equity firms who feed at the public pension trough contributing to pols who will defend this looting. This idea isn’t even a stretch. Look at how real estate developers routinely donate to candidates from both parties (and then late in the campaigns throw bigger sums at the expected winner). But there’s reason to think that the political contribution and payments to allies are so large as to be in the “the difference in degree is a difference in kind” category. Remember, after all, that it was CalPERS that had a former CEO, Fred Buenrostro, go to Federal prison for accepting bribes from placement agents working for private equity firms like Apollo who had not need to pay for access to CalPERS. There’s reason to think the influence operation has become more careful and clever rather than has gone away.