Investors seek answers after Abraaj meltdown

Abraaj Investment Management Ltd. is in liquidation and its founders have been indicted, while institutional investors in its funds and their consultant, Hamilton Lane Inc., are left to deal with the fallout.

On April 11, the Securities and Exchange Commission filed a civil lawsuit against the defunct private equity firm and Abraaj founder and CEO Arif Naqvi for fraud and the alleged misappropriation of more than $230 million from Abraaj's health-care fund. As a result of an audit by some investors in the Abraaj Growth Markets Health Fund, including the $50.7 billion Bill & Melinda Gates Foundation, Seattle, Abraaj was forced into liquidation in June. It managed about $14 billion at the time. On the same day, Mr. Naqvi and former managing partner Mustafa Abdel-Wadood were arrested on U.S. charges of defrauding investors.

What remains to be determined is whether the debacle will lead to investors taking a harder look at the due diligence conducted by their advisers in general and Hamilton Lane in particular. All institutional investors in Abraaj funds reviewed by Pensions & Investments had Hamilton Lane as the private equity consultant.

"Reputation is key" for alternative investment consultants, said Meghan Neenan, New York-based managing director in the financial institutions group of Fitch Ratings Inc. "As alternative investment managers manage more money, there is a huge push from investors for transparency," she said.

While she declined to specifically discuss Hamilton Lane and its Abraaj recommendation, she said that after the Madoff Ponzi scheme came to light, many firms and consultants used the fact that they had avoided investing with Bernie Madoff in their marketing materials "as a selling point." (Fitch does not rate Hamilton Lane securities.)

Hamilton Lane executives declined to comment. But in investor calls and SEC documents, Hamilton Lane executives maintain that the firm has been relatively unscathed financially. Of Hamilton Lane's $141 million in balance sheet assets as of June 30, only $500,000 is invested in Abraaj funds.

"This is not a material exposure for our firm," Hamilton Lane CEO Mario Giannini said during an earnings call. "Hamilton Lane, along with other Abraaj LPs are working closely with the provisional liquidators to facilitate a transfer our responsibility for the management of at least some of the Abraaj investment funds to new managers," Mr. Giannini said in a November earnings call.

A source with knowledge of the situation said: "These issues were destined to come out. The holding company was toxic. … Along the way there were signs and people should have paid attention to the red flags. … It was clear Abraaj was very lackadaisical in the back office, compliance and financial reporting ... but it's hard to blame people looking backwards."

Some consultants passed on recommending Abraaj funds.

"We met with Abraaj several times over the course of months and had concerns," said David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC. "Their statements regarding foreign-exchange management of their investments did not comport with market practices. Also, we were fortunate to be able to speak with former employees who described problematic management practices."

Hamilton Lane clients have about $471 million invested in Abraaj funds, according to SEC filings. This amounts to 0.1% of Hamilton Lane's $471 billion in client assets under management or advisement as of June 30.

Among asset owners that made commitments to Abraaj are the $145.4 billion Teacher Retirement System of Texas, Austin; the Olympia-based Washington State Investment Board, which oversees $128.1 billion in assets including $99.4 billion in defined benefit plan assets; $20.1 billion Louisiana Teachers' Retirement System, Baton Rouge; and the $16.6 billion Hawaii Employees' Retirement System, Honolulu.

The Washington State Investment Board committed up to $250 million in 2017 to Abraaj Private Equity Fund VI, which had a $6 billion fundraising target. However, the commitment was never called, said Chris Phillips, director, institutional relations and public affairs.

The Texas, Louisiana and Hawaii plans also made commitments to Abraaj Private Equity Fund VI in 2017. In February 2018, Abraaj suspended the fund and released investors from their commitments.

However, unlike WSIB, the three funds also committed to an earlier fund, Abraaj Growth Markets Fund.

While only one investor, Texas Teachers, has replaced Hamilton Lane, some investors have called the firm on the carpet for the perceived due diligence lapse.

"It's safe to say that we had a serious and purposeful conversation (with Hamilton Lane) about due diligence," WSIB's Mr. Phillips said in an interview.

WSIB existing contract for private equity research and advice with Hamilton Lane was put in place in 2011 and runs to 2020, he said.

"This contract and the WSIB's ongoing work with (Hamilton Lane) was not altered by this situation with the fund, although our investment team did discuss this fund in some detail with Hamilton Lane in the immediate aftermath of the GP's troubled failure," Mr. Phillips said in a follow-up email.

In July, Texas Teachers allowed Hamilton Lane's private equity consulting contract, as well as the contract of its real estate consultant Townsend Group, to expire on Aug. 31, said TRS spokesman Robert Maxwell in an email.

The board did not discuss the reasons for allowing the contracts to expire.

Hawaii ERS officials rehired Hamilton Lane as its private equity consultant "prior to Hamilton Lane proactively pushing (for) release of our commitment to (Abraaj Private Equity) Fund VI," CIO Elizabeth T. Burton said in an email. Ms. Burton joined as CIO on Oct. 1.

Abraaj Private Equity Fund VI released the pension plan from its $50 million commitment in February 2018, Ms. Burton said. "Abraaj Global Growth remains an active investment and capital calls are necessary to preserve and protect existing investments," she added.

As of Sept. 30, Hawaii has paid $36.4 million to Abraaj Global Growth Markets Fund; the investment was valued at $37.3 million.

However, at the time the board rehired Hamilton Lane, pension fund officials were "fully apprised of the then-existing allegations concerning Abraaj in advance of their selection and rehire," said Thomas "Thom" Williams, Hawaii Employees executive director, in a separate email.

"Certainly, questions and concerns were raised by both staff and the members of our board," he said. "We were provided answers, to the extent available, and concluded our long-standing and rewarding relationship offset any immediate concerns."

Since then, Hawaii officials have monitored developments "very closely," and he said they "are confident that our interests are being well represented."

"Absent such confidence, and as a matter of principle, we would step away," Mr. Williams said.

Hawaii's relationship with Hamilton Lane goes back to 1997; the firm provides discretionary private equity consulting services, Ms. Burton said in her email.

Hamilton Lane oversaw a $1.4 billion private equity portfolio for Hawaii ERS as of Dec. 31, which earned 18.73% for one year, 16.37% for three years, 14.9% for five years and 9.35% since the portfolio's Nov. 1, 1997 inception, topping benchmarks in all periods but since inception, which was at 11.63%.

Louisiana Teachers extended Hamilton Lane's contract as its private markets consultant for one year in November in order to re-conduct an RFP for a private markets consultant "due to the lack of qualifying responses to the original RFP," said Lisa Honore, pension fund spokeswoman, in an email.

Ms. Honore declined to comment regarding Abraaj due to liquidation and SEC proceedings involving the firm.

Daniel Strachman, co-founder of the Coral Springs, Fla.-based organization Investment Management Due Diligence Association, said asset owners are relying too heavily on their investment consultants to conduct due diligence. Many investors still only perform due diligence to the point of making the investment and "are not paying attention on an ongoing basis," Mr. Strachman said.

There's still a theory out there among investors that it is better not to ask about inconsistencies or potential issues than to discover a problem and not act on it, he said. This makes some investors loathe to order background checks, for example. In private equity, limited partners should not only talk to the general partner but also check in with the underlying portfolio companies as part of their due diligence.

Getting the documents from the private equity firm's auditor is just the beginning, Mr. Strachman said.