SACRAMENTO, Calif. - Investment banks with their global reach might be better at finding alternative investments than the traditional pension consulting firms that have funneled billions into the asset class, CalPERS' staff members have told trustees.
As a result, trustees for the $146 billion California Public Employees' Retirement System approved a staff-requested, top-to-bottom evaluation of its relationships with alternative investment consultants Pacific Corporate Group and Hamilton Lane Advisors.
Most pension funds making significant investments in alternative investments use specialized consultants, and a change by CalPERS - which claims to be the first major alternatives client for both firms - could start a trend.
Officials with the two consulting firms were surprised to hear about CalPERS' planned evaluation, which should be completed sometime next year. They said their firms had performed well for CalPERS.
According to CalPERS' records, PCG has provided CalPERS with an estimated 23.7% internal rate of return on partnership investments from March 31, 1990 through June 30, 1998, and a 23% return on direct investments from June 30, 1993 through June 30, 1998; HLA provided CalPERS an estimated 18.7% internal rate of return on partnership investments from 1992 through June 30, 1998. No figure was available for HLA's direct co-investments. Returns over more than one year are annualized.
But a CalPERS staff report cited a number of problems, including potential conflicts of interests and, in one case, massive staff turnover.
Barry Gonder, senior investment officer, said the two firms could be too regional and overextended to compete successfully for the best investment deals globally.
He added, however, the consultants likely would have some role in CalPERS' alternative investment program in the future.
While the criticism was strong, the biggest shock was that the nation's largest pension fund would consider dropping the way it identifies investment deals and, instead, might use an investment banking firm.
Trustees extended Hamilton Lane's and Pacific Corporate's contracts for another year. But a staff report said the evaluation "may result in a recommendation to change CalPERS' consulting arrangement and may include utilization of a different approach."
"We are competing in a much different market" for the best alternative investments than just
months ago, said Mr. Gonder.
"We need to have a local presence, globally . . . in Europe, in Latin America, in Asia. We need people to cover all the different industries. . . . Our needs are expanding faster than these firms are.
"We are competing against large financial institutions, not just other pension funds," Mr. Gonder told trustees.
Christopher J. Bower, founder and chief executive officer of Pacific Corporate Group, said investment banking firms would have many conflicts of interests that pension consultants don't have.
He noted "they are trying to sell other products and services; they are trying to underwrite companies; they are trying to sell investment banking services."
As a result, Mr. Bower said, pension funds "don't have an independent and unbiased investment adviser who is working truly for the benefit of the fiduciary."
The staff report also criticized Hamilton Lane and Pacific Corporate for "organizational issues."
HAMILTON LANE ISSUES
Hamilton Lane's client base has increased rapidly, the report said, prompting these concerns:
*Allocation of investment opportunities among clients;
*Allocation of and strains on the firm's resources;
*Use of a "cookie-cutter approach" - not a customized one - for due diligence and monitoring; and
*Growth in professional staff primarily at the junior level, with CalPERS receiving less attention from senior professionals.
The report also noted HLA has expanded into the fund-of funds business.
"Fund-of-funds management is creating potential conflicts of interests and other issues," the report said. Among them: whether the funds of funds get an unfair advantage in allocation of investment opportunities and firm resources; whether Hamilton Lane will impair its objectivity by becoming sympathetic to general partner issues; and whether other general partners will view the firm as a competitor.
The staff report also noted CalPERS had issues with Pacific Corporate Group, including:
*Three key staff members in CalPERS' contract with PCG have resigned;
*Turnover of professional staff has been high, and PCG has had trouble attracting and retaining qualified professionals;
*Although Mr. Bower will lead the team assigned to CalPERS, he might be overextended with other client obligations; and
*Current staffing at PCG consists primarily of junior level professionals and several new hires.
Mr. Gonder asked that trustees place PCG on probation. But trustee Robert Carlson said, "Singling out PCG for probation really bothers me." He said Mr. Gonder was putting the "scarlet letter" of probation on PCG, which could hurt PCG's reputation worldwide and lessen its ability to make good investment deals for CalPERS.
"We are shooting ourselves in the foot," said Mr. Carlson.
Instead, trustees agreed both consultants should come back to the board early next year with a "plan of action" concerning alternative investments for the retirement system.
In annual evaluations about whether to rehire the firms, trustees had given both consulting firms good reviews. Of a possible 10 points, trustees gave HLA a score of 7.6 and PCG, 7.7.
But the staff rated both consultants as only "satisfactory."
PCG's Mr. Bower expressed surprise that Mr. Gonder recommended probation.
"We have been here for a number of years and had excellent performance," said Mr. Bower.
"We have a team of people in place that have a better pedigree than we have ever had in the history of our organization."
Mr. Gonder couldn't be reached to respond to Mr. Bower's comments.
Leslie A. Brun, chairman and chief executive officer of Hamilton Lane, said he was delighted HLA's contract was renewed; he, too, said his firm had provided good performance.