Readers may find it hard to grasp how successful the private equity industry has been in brainwashing investors, particularly large public pension funds. Investors who ought to have clout by virtue of their individual and collective bargaining power instead cower at the mere suggestion of taking steps that might inconvenience the private equity funds in which they invest.
A recent example comes via the Reuters publication peHub, which discusses their latest information request rebuff. Remember that public pension funds are government agencies, and every state has a version of the Freedom of Information Act. Yet public pension funds routinely turn down requests seeking private equity fund data.
Here are the key details from the Reuters recap of the latest sorry incident. The New York State Teachers’ Retirement System provides only overall data on its private equity returns. The public and its retirees have no idea what particular funds it invests in, much the less how they are doing. By contrast, even though we are in the process of prying more information out of CalPERS, the recalcitrant California giant public pension system, it is a model of transparency compared to New York State Teachers’ Retirement System (it should be noted, however, that CalPERS’ relative openness is the result of a hard-fought court battle by the Sacramento Bee over a decade ago, rather than the result of CalPERS being more public-spirited).
After being nudged via an open records act request, the New York pension fund did disgorge a bit more aggregate data, and provided some basic return information by type of investment, for instance, breaking out IRRs and investment returns since inception for US buyout, US special situation, international funds, and venture capital. The pension fund also disclosed how much it had invested in each strategy at year end 2012 and as of September 30, 2013.
But where the New York teachers’ fund chose to draw the line on disclosure is revealing, and not in a good way. Key details from the Reuters account. Note that even though this article use the word “appeal,” so far the process is internal to the fund. Reuters hasn’t filed a suit.
Buyouts asked for IRRs and investment multiples for each partnership, along with management fees. The pension fund responded that those numbers were off limits. It cited a provision of the state’s open-records act that lets it deny requests of information that “would if disclosed impair present or imminent contract awards” and “are trade secrets …”
In our appeal of that decision, we pointed out that sister state pension funds such as the Teachers’ Retirement System of the City of New York have been disclosing such details about their funds “with no apparent ill effects” on the general partners.
But Kevin Schaefer, the records appeals officer for the pension fund….denied our appeal. He went through six factors used to determine whether information is a trade secret immune from disclosure. The first, he wrote, is “the extent to which the information is known outside the business.”
Buyouts possesses similar information—IRRs and investment multiples, for example—for several funds that are backed by New York State Teachers’ because they are also backed by New York City Teachers’; among them are The Blackstone Group’s fourth and fifth funds. Schaefer did not view our argument through the same lens. The information made public by New York City Teachers’, he wrote, “is specific” to that pension fund and not New York State Teachers’.
Dear readers, I hope you caught this. That argument is laughable on its face. Schaefer is trying to claim that return information that has already been made public is a trade secret. And these returns aren’t investor specific (other investments might be, but not this type). The returns that CalPERS publishes for the funds it is in are seen throughout the industry as official reports on how those funds are doing. Particular investors might have slightly differing commitment dates, but the all get the same capital call notices and distributions.
Back to Reuters:
The second factor was similar to the first, while the third of six factors, Schaefer wrote, is “the extent of measures taken by a business to guard the secrecy of the information.” Buyouts possesses detailed fund information on hundreds of limited partnerships disclosed by sponsors via their pension backers around the country.
But again, Schaefer did not see it this way. “General partners of funds,” he wrote, “take measures to ensure the confidentiality of their investment strategy and fund level performance by providing it only to investors and customarily under confidentiality obligations.” At press time a spokesperson for New York State Teachers’ added in an email that ”the NYS and NYC are separate and distinct organizations which, among other differences, include separately negotiated investment agreements with potentially unique rights, obligations and liabilities—including those governing confidentiality requirements and the protection of trade secrets.”
So basically the negative marks on three of the six tests this fund uses are remarkable stretches. Back to Reuters’ private equity battle:
Buyouts hasn’t decided whether to continue the battle. It should be obvious by now that no harm results from disclosing fund return data, which has been available from pension funds like the California Public Employees’ Retirement System for years following lawsuits early last decade by the San Jose Mercury News…
Is it wise to hide from New York State Teachers’ Retirement System pensioners—including both my parents—how individual money managers are performing, and how much they’re charging?
Don’t underestimate the significance of the “no harm results” remark. That is the rationale these government investors use for blowing off press and other inquiries, that these huge investors might be denied access to the precious “top tier” funds if they do anything that might cross their private equity lords and masters. We’ve already debunked this argument: first, that the idea that investors like the New York Teachers’ Retirement System could out-compete its peers to get into the top quartile funds flies in the face of widely accepted investment logic. And in what should put a stake in the heart of that argument, McKinsey has recently found that those supposedly special top tier funds no longer persist in the top tier. There’s no way ex ante to determine who they are.
This is in keeping with the behavior we chronicled at the Los Angeles pension fund LACERA. As we wrote:
According to LACERA, releasing the real estate contract, “risks alienating alternative fund managers and, as a result, jeopardizing its [LACERA’s] access to top-tier investments.” In other words, the fund managers might get their feelers hurt and will take it out on LACERA by not inviting them in to future deals..
So what LACERA is arguing here is that there is an overriding public interest in avoiding any action on LACERA’s part that might displease its investment managers. Essentially, LACERA has said it will never publicly oppose its investment managers, since any strong action to do so might alienate them. That means, like CalPERS, it will defy clearly settled law and require anyone who wants to get real estate or private equity-related records to sue to gain access to them.
And these investors cling to the belief that they need to be subservient to private equity funds, even as evidence mounts that they are being ripped off. From SEC Chairman Mary Jo White’s testimony yesterday before the House Financial Services Committee:
In addition, since the effective date of the Dodd-Frank Act, approximately 1,800 advisers to hedge funds and private equity funds have registered with the SEC for the first time… Some of the common deficiencies from the examinations of these advisers that the staff has identified included: misallocating fees and expenses; charging improper fees to portfolio companies or the funds they manage; disclosing fee monitoring inadequately; and using bogus service providers to charge false fees in order to kick back part of the fee to the adviser.
Both the description of the abuses and an earlier leak by the SEC about the high level of fee abuses it is finding at private equity funds suggest strongly that these scams are primarily, if not entirely, at private equity firms, and they are not mere mistakes. Yet public pension funds continue to stick their heads in the sand and pretend that the private equity industry has their best interests at heart. They are about to get a rude and embarrassing awakening.
44 comments
Comments are closed.
I wonder how the public pension plans in such states as Washington ($1.67 billion) and Oregon ($1.3 billion) feel now about their investments in KKR Fund 2006, which just took a big hit this week when Energy Future Holdings filed for bankruptcy. What have they been telling their pensioners about how well these investments have been doing over the years? How many other states are going to lose money on that mega-deal? Maybe all that secrecy got them was a ticket to a bottom quartile private equity investment.
Yikes! Oregon’s state employee pension fund, PERS is already a mess. I don’t know the details, but in the 90s Oregon offered to match, dollar for dollar, the individual employee managed fund at retirement. This when the stock market was doubling every few years. Today, many of those employees are retired at more than their highest annual salaries while working. Hence, the state is severely cash-strapped. Add in this loss of a significant portion of the funds reserves and we have a recipe for financial disaster. While I stand to benefit from a public pension fund, doggone it, I want the state to survive – and the fund to survive. So listen up pols. Hire a competent financial advisor before you offer benefits you may not be able to afford. Do your darn homework. We don’t need our police and firemen to retire at 45, in fact, given the trigger-happy behavior we have seen among the younger police officers, it would seem a good idea to have numbers of cooler-headed (if somewhat balder) grey-beards to show these cowboys how to rope a steer without killing it.
And here in Canada, pensions are loading up n alternatives forcing everyone into the game:
April 29,
http://bpmmagazine.com/benefits_news.php
And government doubles its issue of 50-year treasuries priced at less than 3% from 750m to 1.5 billion… Who’s buying this? Pensions and insurers of course… it’s nice that government can borrow at these low rates. However, someone will get caught with the short end of the stick if inflation and rates creep up, and it will be retirees.
The lower 70% was squeezed over the last couple of decades. Now the squeeze is moving up the wealth curve towards the next 10-20% who have pensions.
I’d suspect a revolving door before I looked for Stockholm Syndrome. Capture seems to come in two ways, one through delayed gratification (getting a big salary when moving from the Pension Fund to a financial institution/hedge fund) or by crony cross-promotion resulting in salary inflation at the job with the purported fiduciary responsibility. This business of not wanting to offend the salesman is not unique but it almost always reflects graft of some sort another.
And again, genteel readers, ENVELOPES (and briefcases) full of cash. It works for Judges, it works for all but the very top, where gifts of higher value are bestowed. Do not overlook the simple explanation. Check the life-style of those who direct billions to these funds- do their salaries explain the life-style? New York is as bad as Chicago.
No, these guys get in SERIOUS trouble for stuff like accepting flights on private jets. Look at CalPERS. The head of the investment area lost his job over that. The former president is being prosecuted (as in criminal charges!) over suspected kickbacks from a fund consultant. The ethics rules are pretty tough.
That isn’t to say that there aren’t indirect inducements. At the biggest public pension funds, some of the board members are elected officials. So they have reason not to want to get tough with the industry. They all might start funding their next electoral opponent in a big way.
I think Yves is being very kind in that title :)
No, the guys who run state and local pension funds never get hired by the industry. The PE industry is full of men with glittering resumes or tons of operating experience. The guys at who work for the states and local governments went to what the PE guys regard as second or third tier schools, have no deal experience, and in the rare case that someone has an advanced degree, it’s again not from an impressive school. By contrast, DC is full of people with advanced degrees from top schools and/or very impressive prior experience at the senior regulator level. They have to be articulate and presentable since they get dragged before Congress on a regular basis.
But the fantasy that they might nevertheless land a job is a big disincentive against pushing back.
I know you’ve got a lot invested in this meme, but the idea that if you went to an American Oxbridge equivalent you are better and smarter than everyone else is a scam. Bush I and II, Roberts, Alito, Clinton, Obama, George Schultz, the list is endless, all went to elite universities and the idea that they are oh so much brighter than everyone else is just not true. They knew how to take tests and game the system, period. Elite education has as much to do with class, race, ethnicity, and an all-consuming drive to go to an elite school as it does with raw intelligence.
I mildly and respectfully disagree. I doubt that either intellect or leadership performance of those gents differentiates them in any way from you or I. What is different is their demeanor, self-assuredness, elocution (OK, that’s not true of GWB), rhetoric, and most of all, their connections to the levers of power. So, I don’t think a Yale MBA knows business better than an Oregon State MBA, or at least, not much, but Yalies and their like are much more comfortable asserting their obvious expertise and self-confidence sure as hell does make a difference.
An interesting and smart corrective–thank you. I don’t think it substantially negates what I said (although I in retrospect overstated my claim), but it is a powerful reminder of the attributes of success. These seem to be, in this culture: being white, male, tall, handsome, energetic, confident, and convincing. I can see how an elite education can reinforce the last two of those attributes. The others you are born with. And note that superior intelligence, forget about wisdom, is not an essential, or even critical, part of the mix.
I think you are actually missing something. There is industry know-how (finance trade craft, basically) that you can acquire only by having worked in PE (getting hired as a junior, which is rare) OR working in investment banking, or working for a wealthy family or large privately held company (like Cargill or Landmark Communications) that does a lot of deals. Lawyers can get hired, but they usually work for a deal operation before going over to a PE firm, they very rarely go directly from a law firm.
This does not have to do with intelligence. This has to do with having acquired highly specialized skills. But the career paths for obtaining those highly specialized skills are open pretty much only to people who went to an elite grad school.
Now as I indicated, you can get in by being a successful “operator” as in corporate exec. You don’t need to have a fancy education for that but you need an established track record. But people like that would not be working for a public pension fund.
I appreciate the politeness of the rebuke. What you say is worth considering. Deep down, I’m reacting to experiences I’ve had at two institutions of higher learning where the default choice for new hires is always an Ivy, based on the annoying fact that if you pick someone from Princeton and it doesn’t work out, no one questions your choice, whereas if you pick someone from Texas or Wisconsin and it doesn’t work out, the inevitable question is “why the fuck did you pick that woman from Wisconsin? wasn’t there anyone in the pool from Princeton?” The advantage this bestows to the already privileged is obvious.
That is an unwarranted comment. When I was in a position to hire people (starting up an M&A department), I did not hire people from elite US schools or Oxbridge. I am describing OTHER PEOPLE’S BIASES.
I am acutely aware of this type of bias and have written about it:
http://www.auroraadvisors.com/articles/Fit.pdf
The PE funds are if anything nuttier than the investment banks about hiring people only from a very narrow set of backgrounds. And as one of my colleagues pointed out, this isn’t about perceived or actual smarts. There are tons of smart people who didn’t wind up at fancy schools for all sorts of reasons, particularly starting in the 1990s when the cost of college started exploding.
It has to do with the fact that to get that kind of resume, you need to be extremely insecure. The industry screens for that. They want people who will take any directive and not question it. And that particular type of compliance also means they won’t question rule breaking or sharp practices.
Oops, please see above response.
I served on a small local government pension board. And so while not perfectly representative of the monster funds, I will say the ethos was very much about risk reduction in terms of following the herd.
We hired an investment adviser who proposed investments and we voted yea or nay. We basically approved what we got recommended, assumed he had done his homework, and finished our meetings on time. Occasionally we asked them to look into something, but basically they did all the pre-screening for us, including deciding what universe to include in their review.
The sole criteria for our performance was: how are we doing compared to our peers. Up market, down market, sideways market; the only thing that mattered was were we in with the lemming herd or not.
“I will say the ethos was very much about risk reduction in terms of following the herd.”
Haven’t we figured out by now that following the herd and risk reduction are diametrically opposed?
On the contrary. the risk is in sticking your neck out.
Going off a cliff with other people’s money is no problem, provided you go off the cliff in a herd.
The problem is of even larger scope than PE. People should not even have a fund for their pensions that has fiduciary duty. Instead they should each have their own self-directed pension account. Inserting large institutions invites corruption of a larger scale. A sekf-directed account will over the long term give people incentives to invest conservatively meaning a lot of fixed income, and increase their incentive to complain about inflation or increase their investment prowess. Instead we now have this web of fraud and skimming and a clueless population.
Not everyone can do it on their own. That’s why I think there should be a basic pay-as-you-go pension, not funded but paid out of the annual government budget and if people want more, then they can save/invest on their won with no government intervention.
Ya I guess even if we do keep pension funds, they should still in my view invest in a lot “safe” investments like government bonds and various solid yield product, on purpose, so that people KNOW that they have fixed-income investments and are thus sensitive to inflation eating up their savings. What we have now is a promise that funds will be invested in “better” stuff like PE and all kinds of other funds and equity-oriented products that, while good in theory against a background of inflation, are skimming and abusing and speculating etc.. while at the same time keeping the populace quiet because they are seen as premium and equity-like (i.e. the best type of investment in theory).
Also, notice the following: we get a downturn like 2009, but the rebound was very quick, it wasn’t a bounce along the bottom like the early 80’s or the great depression. The elite + investors who are savvy picked up bargains or semi-bargains very quickly and everything got expensive again by 2010. So really, all these pension funds are mostly entering investments at fair to high valuations while managers skim all their fees and do all the other evils that Yves has highlighted.
The problem is return on government bonds does not now, nor has it for years, keep even with lived inflation. To invest in government bonds or CDs is to lose money. I’m thinking of dumping my retirement money into CDs just to keep the principle if the shit hits the fan. But in the long run, it means a diminished material existence for me and my wife.
Right… but that’s what I’m saying: For you and your wife it’ll suck but your grandchildren will be taught to watch out for inflation and to hold government and plan managers responsible for correctly reporting inflation and keeping up with it. Maybe Utopian but I like that better because vigilance is healthy.
Yep. The monetary sovereign is the logical provider of pensions since it is immune to the boom-bust cycle and can never go broke.
And if we want to maximize the real value of fiat then we need to quit thinking that government-backed banking is anything but trouble waiting to happen.
+100.
‘McKinsey has recently found that those supposedly special top tier funds no longer persist in the top tier. There’s no way ex ante to determine who they are.’
Funny … that’s exactly what decades of research on active managers of publicly-traded equities also shows. Chasing this year’s ‘hot hands’ doesn’t produce outperformance next year.
What is dead-nuts certain, though, is that consistently paying high fees will drag down net returns to below-market levels. John Bogle pointed that out forty years ago, and he’s still saying it today:
‘It doesn’t take a genius to know that the bigger the profit of the management company, the smaller the profit that investors get.
‘Cost is a crucial issue, how the returns of investing are allocated between investors and money managers or marketers. So the money managers always want more, and that’s natural enough in most businesses, but it’s not right for this business.’
http://www.pbs.org/wgbh/pages/frontline/business-economy-financial-crisis/retirement-gamble/john-bogle-the-train-wreck-awaiting-american-retirement/
————
You and I could blow half these PE funds out of the water just by holding a one-issue portfolio, SPY. Its annual expense ratio of .0945% wouldn’t even buy lunch for a white-shoe PE honcho. It don’t take no PhD Econ to win a race against sticky-fingered Wall Street boodlers.
If everyone goes index, that means no research is done and all securities get mispriced. Passive is essentially piggybacking on others’ work… I thought we were looking at fixing our system to get out of the free lunch and greater fool philosophy.
Yeah, I think that point is starting to gain some traction. What I like to call the Vanguard Externality isn’t a solution; it’s just free riding on the work of others. Somebody has to decide how to allocate resources.
I find it especially hilarious when there is a complaint about the particular behavior of a large corporation. Almost without fail, it is widely owned by index funds and public pension funds.
While you and Moneta point out the bad optics of index investing, the inescapable fact is that active investing is not a long term success story.
It’s a simple cost/benefit ratio. Otherwise known as efficiency. Paying for active management isn’t a wise use of resources, and even the least financially savvy teacher (or any wage-earner) can do the math.
Yes. I am in no way denying that indexing has offered better outcomes for many but it remains a strategy based on a free lunch. When we will reach a tipping point where too many investors are going that route, indexing will fail… because the smart money will get out due to mispricing… and ETFs are the catalyst.
Hence the concept of free riding.
Owners of companies either invest the time and energy necessary to have good governance, or they don’t. If these investors can externalize the costs of bad governance onto society, then it is quite efficient from their perspective to do so.
P.S., if you’re curious about this topic, the internet is great for finding more info. I would encourage just browsing around Yahoo Finance for a while. Pick a major company, and then look at the top mutual fund holdings. You’ll find entries like Vanguard Total Stock Market Index Fund and SPDR S&P 500 ETF Trust. From the perspective of investors, these are fantastic tools.
The larger systemic issue, though, is that the whole point of using passive management index funds is to not spend time thinking about the responsibilities of owning an equity stake in a business. I’ve linked a couple examples from fossil fuels and finance below:
https://finance.yahoo.com/q/mh?s=XOM+Major+Holders
https://finance.yahoo.com/q/mh?s=GS+Major+Holders
‘If everyone goes index, that means no research is done and all securities get mispriced.’
Not everyone is going to index, ever. Corporate insiders, for one, who have to report their trades. Fundamental funds, for another, who seek value based on price-to-book, earnings or dividends.
Active managers as a group don’t, and can’t (owing to fees) beat passive management. This applies in spades to private equity where fees are high, and excessive leverage guarantees an ugly washout in the next recession.
Given the secrecy involved, PE would be a probable place to look for the ‘next Nick Leeson.’ That is, under-report and carry losses (using opaque valuations), hoping to make them up in the bounceback. Then hit the lecture circuit, yo:
http://www.nickleeson.com/
I said everyone to make a point, not to be literal. All you need is to reach a tipping point where enough investors buy the index without doing their homework and you get a whack of mispriced securities… these can get mispriced because of animal spirits but also because a large percentage of investors are just buying the index, therefore just buying more of what has already gone up. I think this ETF fad is creating huge mispricing.
Already happened. There are already too many indexers and the “index effect” is already documented.
Yes. I am in no way denying that indexing has offered better outcomes for many but it remains a strategy based on a free lunch. When we will reach a tipping point where too many investors are going that route, indexing will fail… because the smart money will get out due to mispricing… and ETFs are the catalyst.
Sorry this is for scraping_by
Well, we’re by and large talking about the secondary market. The social utility of investing is problematic in the first place, hedged with many caveats and provisos, but once you’re past a direct partnership with someone in the real economy it’s more dependent on social behavior than any economic utility.
Indexing actually depends on large numbers of investors. It’s that pesky reversion to the mean. Not to mention the business cycle, which supply-siders pretend not to see. Over a long enough time frame, the crowd is right because they are the crowd.
I’m not sure the economic term ‘free rider problem’ applies to passive investors. Putting money at risk is doing something, not really analogous to trucking without paying road taxes or hiring university graduates while not paying taxes to support universities. True, it’s not much, but it is something.
No, most investor fees don’t buy advantages, they just support a social class.
That will never happen. Too many people believe they can be the next Warren Buffet, and there are fund managers that can round up client money on that basis too.
Maybe… but I tend to think the ETF fad is creating a lot of mispricing.
Public pension funds in the US don’t use ETFs. The charges are higher than what institutions pay and you have tons of tracking error. The bigger public pension funds run their index fund internally, they can do it for cheaper than what it cost to invest in an institutional index fund at Wells Fargo or State Street.
If the link remains functional, rather humorous article yesterday by Matt Levine on Bloomberg about the history of Energy Future Holdings Corp that might give pause to those fund managers who rely on Private Equity’s supposedly superior deal access, risk management, and analytical skills. Biggest bankruptcy since Enron and the largest LBO ever: http://www.bloombergview.com/articles/2014-04-29/largest-leveraged-buyout-ever-is-finally-bankrupt
Will be interesting to see if this BK affects bond prices, and particularly prices of junk bonds.
Stockholm Syndrome indeed. Recalling Richard Pryor in the great film, Car Wash: … “Who you gonna believe, me or your lyin’ eyes?”
The TXU train wreck has been going on for some time and is not news to the industry.