BEVERLY HILLS, Calif. — The use of leverage, the salvation of alternative investments and the problems of public pension funds were among the topics at the Milken Institute’s 10th Global Conference April 23-26.
The Santa Monica, Calif.-based Milken Institute, the creation of convicted junk bond trader Michael Milken, hosts an annual event that brings together executives from a variety of fields — buyout and real estate to health care and public education. The event, which attracted more than 3,000 people this year, was the largest Milken conference ever: lunch and seats for the most popular of the panel discussions went to the swift.
Rubbing shoulders with Rosey Grier and Sumner M. Redstone were a cavalcade of institutional investment luminaries. Bradley Belt, founder and chairman of Palisade Capital Advisors and former executive director of the Pension Benefit Guaranty Corp. moderated a panel on the future of public defined benefit plans.
Turning up at the Beverly Wilshire Hotel in Beverly Hills were buyout heavyweights Leon Black, founding partner of Apollo Advisors LP; David Bonderman, principal and founding partner of TPG (formerly Texas Pacific Group); Thomas Lee, president and CEO of Thomas H. Lee Capital LLC; and David Rubenstein, managing director of the Carlyle Group.
The heady mix of topics included a discussion of whether financial innovation is passe and whether real estate is encroaching onto private equity turf. And the 120 sessions, many taking place simultaneously, would have made roller skates more useful footwear than pumps and wingtips.
The use of leverage came up several times on panels concerning capital markets in general, private equity, real estate and hedge funds in the course of the three-day event. During a panel on hedge fund regulation, Marc Lasry, founder and managing partner of Avenue Capital Group, and Robert Matza, partner and president of GoldenTree Asset Management LP, differed on whether hedge fund failures were caused by excessive debt. Mr. Lasry said the bright light of federal regulators was shone on the hedge funds following industry failures such as the Amaranth debacle, caused, in part, by the firms excessive use of leverage. Mr. Matza said leverage use today is less than a decade ago.
Numerous examinations of private equity and the future of the asset class were made. One panel on whether classification of investment styles still makes sense was moderated by Robert Lessin, vice chairman of Jefferies & Co. Panelists were Mr. Black of Apollo Advisors; Gregory Fuss, senior vice president of the Capital Group Cos.; Michael Keough, principal of Stark Investments; Andrew Rosenfield, managing partner of Guggenheim Partners LLC and founder, president and chief executive officer, Leaf Group LLC.
“I’m a glass-half-empty person,” said Mr. Black. “Prices feel very full. There’s a lot of activity.” Returns are dropping because of the high prices in deals that include more cash and aggressive debt, he explained.
“Whenever it’s felt this full I’ve felt that we’re on the edge of a precipice, but I don’t feel that way,” Mr. Black added. Inflation is under control and the amount of debt issued as a percentage of gross domestic product “is not alarming.”
What will change this will be a surprise, such as Iran sinking a U.S. oil tanker to shake things, he said. This type of unexpected event will have such an impact that hedge funds will not be able to redeem, Mr. Black said.
Mr. Belt moderated a panel on paying for retiree pensions and other benefits. U.S. pension funds have a collective unfunded liability of more than $1 trillion, he noted. Panelists differed on whether boosting returns by increasing alternative investments or focusing on liabilities was the most appropriate course of action deal with the deficit.
The panelists agreed that public plans did not pay enough attention to risk in their portfolios until recently. Gerald Parsky, partner at Aurora Capital Group, is on a bipartisan commission appointed by California Gov. Arnold Schwarzenegger on the issue. He said in the 1990s, the University of California — which has a $60 billion pension plan and $5 billion endowment — had an asset allocation of 65% equities and 35% bonds. But 45% to 50% of the equity allocation was in 14 stocks, he said. “They happened to be good stocks, but there was no appreciation for the risk side of things.”
New Jersey State Investment Council officials never measured the risk-adjusted returns of its $78.1 billion in pension assets or compared their returns to their peers before 2003,said Orin Kramer, general partner at Boston Provident LP and chairman of the New Jersey State Investment Council, Trenton. The fund lost money between 2000 and 2002 but now is in the top 4% of all public pension funds of similar size, he said. The fund has a long-term target allocation expected to be reached by 2012 of 19% in alternative investments: 6% hedge funds and the remainder divided equally between real estate, private equity and commodities/real assets.
Institutional investors are using private equity, hoping the anticipated returns will reduce unfunded liabilities, Mr. Parsky noted.
Texas Teacher Retirement System reduced its domestic equity allocation to 25% from 60% to boost its alternative allocation to 35% from less than 5%, said Jarvis Hollingsworth, partner at Bracewell & Giuliani and chairman of the board of the $106 billion system in Austin. The board will be reviewing an implementation plan this month, but Mr. Hollingsworth said he expects the pension system to take two to four years to switch to the new allocation.
Mr. Belt then asked the panel whether public pension fund officials are focusing too much on returns.
“Are pension funds reducing risk or juicing returns?” asked B. Scott Minerd, chief executive officer and chief investment officer of Guggenheim Partners Asset Management. “It’s an urban legend that a lot of the problem will be reduced by increasing the return of the investment portfolio. It’s hard to accept the cold hard reality. … The public sector’s lulling itself to sleep believing in returns” instead of focusing on increasing contributions or reducing benefits.
Mr. Belt quipped in response: “There are a lot of fairy tale tellers with portable alpha.”
