CalPERS panel to look at private equity hirings

Under pressure from state lawmakers and groups representing minority and women-owned private equity managers, the $269.1 billion California Public Employees' Retirement System has launched a task force to address how it can better evaluate which emerging private equity firms to fund.

The task force's creation comes as the nation's largest defined benefit plan has been reducing the amount of capital commitments it makes for funds being raised by emerging private equity managers specifically and all private equity managers in general due to the slowed economy.

The Sacramento-based pension fund has been one of the leaders in hiring emerging private equity managers. A CalPERS capital commitment can be a national seal of approval that can help fledgling firms attract other investors and become successful.

CalPERS defines emerging managers in the private equity area as those raising their first or second fund. Many are also owned by women or minorities, but under California law, racial or gender preferences cannot be considered in the selection process.

But race, ethnicity and gender are issues underlying the debate.

Several informed sources, who would only speak anonymously, said the task force's creation helped put the lid, at least for now, on what CalPERS officials viewed as a lengthy and unwarranted state audit of CalPERS' emerging manager programs.

The audit was being pushed by state Sen. Ricardo Lara, a Long Beach Democrat and vice chairman of the California Legislature's Joint Committee on Legislative Audit, as well as chairman of the California Latino Legislative Caucus.

In an e-mail to Pensions & Investments, Mr. Lara said “one of my priorities is to ensure that California is working toward expanding management and leadership opportunities to Latinos and minorities in general. ... I am pleased that CalPERS is committed to looking at its policies and procedures.”

The task force, which will be made up of CalPERS investment staffers and private equity consultants, is expected to start meeting in the next several months.

Laurie Weir, CalPERS senior portfolio manager, targeted investment programs, said the economic crisis caused the pension fund to put greater emphasis on risk management, resulting in a tighter selection process for new funds.

Ms. Weir said CalPERS made $36.7 billion in private equity commitments between 2006 and 2008, of which $6.9 billion went to emerging managers. Between 2009 and 2012, the pension fund committed $5.2 billion, including $943 million to emerging managers. In both cases, she said CalPERS committed 18% of assets to emerging managers.

“Emerging managers by definition are smaller firms raising first or second time institutional funds, which would make it more difficult to weather the storm of the global financial crisis,” Ms. Weir, CIO Joseph Dear and Christine Gogan, senior portfolio manager, private equity, said in an Aug. 19 memo to the investment committee.

Officials of the National Association of Investments Companies, a trade group representing around primarily minority- and women-owned private equity managers, have contended members were not given fair consideration by CalPERS in recent years.

Over the last two to three years, investment staff at CalPERS virtually stopped making additional fund commitments to existing emerging private equity managers with solid investment performance, said Robert Greene, a special adviser to the association and a principal with Syncom Venture Partners, Bethesda Md., an NAIC member firm. He said while CalPERS has kept the percentage of funding for emerging managers at 18%, allocations deserve to increase if emerging managers can outperform non-emerging managers.

“CalPERS can make the tactical decision to invest more with emerging managers,” he said.

Mr. Greene said CalPERS staff didn't tell managers why they were being rejected and ignored requests for details. “Our only conclusion was that CalPERS was not fully considering them,” he said.

CalPERS Acting CIO Theodore Eliopoulos acknowledged that the pension fund can do a better job of communicating with emerging managers, promising at the August investment committee meeting to have a dialogue with rejected managers in the future.

A second trade group, The New American Alliance, which represents Latino money managers, also expressed concern about the reduction in funding for emerging managers “CalPERS had been a leader in the space,” said Maria del Pilar Avila, the group's CEO. But she said her group hasn't pushed for an audit of the emerging manager program, preferring to work with CalPERS.

But CalPERS board member J.J. Jelincic said emerging firms need to make a case for their hire. “We have an obligation to our beneficiaries, we do not have an obligation to make everyone rich,” he said.

And performance is an issue.

CalPERS' emerging PE managers have underperformed non-emerging private equity managers, according to Crosswater Realty Advisors, a Los Angeles consultant hired to evaluate CalPERS' emerging manager programs.

A Crosswater report released at the August meeting found that between March 1, 1990 (inception of the private equity emerging manager program) and June 30, 2012, emerging managers underperformed other private equity managers. Emerging mangers had a compound annual 9.6% rate of return compared to10.6% for non-emerging private equity managers.

Mr. Greene said a 2012 study by NAIC found that emerging managers outperform non-emerging managers. He said the study captured a representative sample of 14 of the association's members firms between 1999 and 2011, and found that the median internal rate of return was 15.2%, compared to a 3.7% for all private equity firms.

The Crosswater report recommended CalPERS do an in-depth review of success factors that have led some emerging managers to outperform. Ms. Weir said the task force will examine those issues.

Another issue regarding emerging managers was CalPERS' termination in September 2012 of Centinela Capital Partners LLC, a minority-owned firm with a $1 billion manager-of-managers program.

Six months earlier, Centinela had filed a complaint with the California Victim Compensation and Government Claims Board, saying it was promised $100 million in new capital if the company removed the firm's Latino-co founder Cesar Baez because of his alleged connections to an unnamed placement agent under investigation for his work with the pension fund.

That complaint was dismissed, but Centinela is suing CalPERS for breach of contract. Michael Stern, a California Superior Court judge, last month rejected the breach of contract charges and a charge that CalPERS had racially discriminated against Centinela. The company subsequently filed an amended suit on the contractual issues.