Los Angeles City Employees' meetings illustrate potholes on the path to private equity investing

Los Angeles City Employees' Retirement System extended the contract of private equity consultant Portfolio Advisors LLC to July 11, 2018, but the decision came after a saga that exposed the difficult job investors have to gauge consultant performance even when they try to get apples-to-apples comparisons, audio recordings of the board's June 13, July 11 and July 25 meetings show.

LACERS' board discussions also went to the heart of what investors expect from their private equity portfolios: a larger number of smaller commitments to hard-to-access funds or larger commitments to fewer funds.

The board had issued an RFP for a private equity consultant last October, but canceled it at the July 11 meeting. It expects to have a new RFP completed before July 11, 2018; Portfolio Advisors will be invited to rebid.

Thus far, LACERS has been on a wild ride. Along the way, the board has received staff reports that first recommended one consultant, then switched to the other finalist, and then last, asked for more time to rectify issues with the finalists' performance reports.

The board of the $15.7 billion pension fund board canceled the original RFP at its July 11 meeting after at least one board member, Nilza R. Serrano, voiced concerns with Portfolio Advisors' response to a request to provide return information of its clients, according to an audio recording of that meeting. In answering the request, Portfolio Advisors had omitted the returns of one of its largest clients, the $52.7 billion Pennsylvania Public School Employees' Retirement System, Harrisburg. In the response, the consulting firm reported returns on $16 billion of its total $37 billion under management, among other things.

LACERS has a 12% allocation to private equity, which it classifies as alternatives. The pension fund's $1.4 billion private equity portfolio has underperformed its benchmark for the one- and five-year periods ended March 31, according to the pension fund's most recent performance report.

At the July 11 meeting, LACERS staff also changed its stance from recommending Portfolio Advisors be rehired to a request that the board defer selecting a private equity consultant. The change was due to “confusion around the numbers submitted by the firms,” said Rodney June, chief investment officer, according to the recording. He added the other finalist, TorreyCove Capital Partners LLC had provided more “complete disclosure” than Portfolio Advisors.

“I don't understand why they took out clients that did not make them look good,” Ms. Serrano said at the July 11 meeting, regarding Portfolio Advisors' response to the request for performance data. “They took things out that manipulated the numbers and that is a violation of the CFA Code of Ethics.”

The recording of the July 11 meeting includes a disclaimer that a statement read by Ms. Serrano at the meeting regarding her concerns about Portfolio Advisors' reporting represents her personal views and not the views of LACERS.

Commissioner Elizabeth L. Greenwood added the consultant should have provided data with and without the missing roughly $22 billion in AUM — the difference between the assets under management stated on its website and the $13 billion it used for its returns. Mr. June agreed that providing returns using both numbers “would have been a better approach,” according to the recording.

Portfolio Advisors only included the LACERS returns for the three years it ran the discretionary mandate for the pension fund's $1.4 billion private equity portfolio, Brian Murphy, managing director at the Darien, Conn.-based consulting firm, explained at the July 25 board meeting. Portfolio Advisors did not include the LACERS' private equity portfolio returns from when the portfolio was managed by its prior consultant, Hamilton Lane.

Mr. Murphy explained Portfolio Advisors does not include the performance created by Hamilton Lane but the Securities and Exchange Commission requires the firm to include those assets in its AUM.

Portfolio Advisors likewise does not include $17 billion in unfunded commitments in its internal rate of return but it does add unfunded commitments to its AUM, Mr. Murphy said. Portfolio Advisors also excludes clients' co-investments and investments on the private equity secondary markets from its track record to avoid “double counting” assets, he said at the meeting, the recording shows.

He explained that Portfolio Advisors excluded PennPSERS “for consistency purposes.” Portfolio Advisors began working for PennPSERS 15 years ago, when it was the largest investor in the asset class and could make tough demands on general partners. Therefore, PennPSERS is not representative of what Portfolio Advisors does for the rest of its clients, Mr. Murphy said. For example, PennPSERS required private equity managers to commit at least 5% to their funds when it was common for managers to commit only 1% to their funds, he said. He told the LACERS board that PennPSERS' private equity portfolio IRR was 11.25% for the 15 years Portfolio Advisors served as its consultant.

PennPSERS replaced Portfolio Advisors with Hamilton Lane as its private equity consultant in June.

Mr. Murphy said much of this explanation was included in the footnotes to Portfolio Advisors' submission.

He added he was “a little disappointed that we've been working with you for three years and we got zero benefit of the doubt,” according to the recording.

“I was given four sheets of paper to make my decision,” Ms. Serrano said in response. “I have to go back and peel the onion … so that I can make a decision” in the best interests of retirees.

A contentious exchange followed over representations of both sides in news stories.

Mr. Murphy said it was not fair “when the press wants me to comment on the slanderous comments in a board meeting.” He added he was displeased with being blindsided by calls from the press when the information was available to the board in the footnotes of the firm's report. (He said it was the press that labeled the July 11 statements about Portfolio Advisors as slanderous.)

The recording continued with Ms. Greenwood saying she was displeased that Mr. Murphy was quoted in news reports as referring to Ms. Serrano as “that woman who does not read.”

Finally, the board at the July 25 meeting decided to extend Portfolio Advisors' contract for one year, and to pursue some education to determine what to expect from its private equity portfolio, before relaunching the private equity consultant RFP.

“My recollection is we wanted to be a bigger fish in a smaller pond,” Ms. Greenwood noted. The idea was to commit larger amounts of capital to a smaller number of private equity firms, she said.

“Why switch private equity consultants (to Portfolio Advisors from Hamilton Lane three years ago) if we were going to continue to make $5 million commitments,” she said.”What is our strategic plan for private equity?”

Ms. Serrano urged the rest of the board to “figure that out” but expedite the search process and launch the RFP “sooner than later.”