Originally posted at CalPensions.
By Ed Mendel.
CalPERS is not investing enough money through minority-owned firms, two trade associations and several money managers say, and some want a legislative audit of “unfair” decisions, particularly for lucrative private equity funds.
The complaints caused CalPERS, which regards itself as an historic leader in investing with minority firms, to respond with plans for better communication with minority firms and a task force to look for ways to identify firms that will be successful.
The big pension fund is “very confident” that its selection process would be validated by an audit, the CalPERS board was told last week. But there have been meetings with “17 legislators or their staff in recent weeks” to explain the program.
“I am confident we can move forward in a collaborative manner,” said Ted Eliopoulous, CalPERS senior investment officer. “It’s the manner this board has led this institution and directed staff over many decades.”
As a public agency controlling a huge fund valued at $263 billion last week, the California Public Employees Retirement System is expected by many to pursue various social policies with its enormous investment clout.
Some examples: Divestment of stock in companies doing business in certain countries (apartheid South Africa) or producing certain products (tobacco); labor unions asking that shareholder influence be used on their behalf in strikes (Houston janitors).
But investments made for social goals can conflict with the CalPERS duty to give member benefits top priority. Proposition 162 in 1992 also gave CalPERS sole control of its funds, a safeguard against legislative raids or meddling.
Another problem for increasing CalPERS investments through minority-owned firms is Proposition 209 in 1996, which prohibits discrimination or preference on the basis of race, sex or ethnicity in public employment, education and contracting.
So the discussion is about making more investments through “emerging managers,” a broad category said to have a higher proportion of minorities and women than well-established firms.
A business rationale, apart from the social goal of broader participation, is that some startup firms have energetic new talent and ideas that may not be found elsewhere, giving investors a chance to get in early and catch the next wave of profitable success.
Legislation two years ago required CalPERS and the California State Teachers Retirement System to provide a five-year strategic plan for emerging investment manager participation across all asset classes.
Under SB 294 by former Sen. Curren Price, D-Inglewood, the definition of “emerging investment manager” is left to the boards of the two retirement systems, which must submit an annual report on the progress of the plan.
“At CalPERS, emerging managers are generally defined as newly formed or relatively small firms,” usually raising institutional funds for a first or second time, a CalPERS report said last March.
The complaints that CalPERS has not invested enough with emerging managers came from the New America Alliance, a Latino business group, and the National Association of Investment Companies, which boosts minority and women managers.
CalPERS faces lawsuits alleging racial discrimination after firing a minority-owned private equity firm last year, Centinela Capital Partners, that had been managing $1 billion in CalPERS funds and yielding low returns.
A Centinela co-founder, Cesar Baez, is seeking $30 million in damages. He alleges CalPERS broke a promise to give Centinela more funds if Baez was forced out because of his link to businessmen accused of misusing “insider” CalPERS relations.
The reference presumably is to Alfred Villalobos and Fred Buenrostro, former CalPERS officials facing bribery-related charges. Villalobos, a placement agent, got more than $50 million in fees from private equity firms receiving CalPERS investments.
The Baez suit said the CalPERS decision to oust him was “racial profiling and bias” that assumed because he is Latino he must be part of a ring of Latino influence peddlers, Private Equity International reported in March.
CalPERS, also sued by Centinela, said the offer of more funds for Centinela if Baez was ousted undermined the claim of discrimination. CalPERS began a five-year restructuring of private equity in 2011 that apparently included dropping Centinela.
Private equity is expected to provide above-market returns for CalPERS and CalSTRS. The private equity target allocation is, respectively, 14 percent and 12 percent of their total investment portfolios.
Whether private equity, particularly leveraged buyouts, is “creative destruction” for more productivity or “vulture capitalism” that cuts jobs and product quality was part of the presidential campaign last year because of Mitt Romney’s time at Bain Capital.
Private equity has been very lucrative. The mystery bidder who paid a record $120 million for Edvard Munch’s “The Scream” painting last year turned out to be Leon Black, whose Apollo private equity funds paid Villalobos more than $40 million in placement fees.
Private equity had explosive growth during the last decade, thanks in large part to public pension funds. CalPERS committed $36.7 billion to private equity during 2006-2008, approving 131 proposals.
But following an industry trend after the stock market crash in 2008, CalPERS committed $5.2 billion to private equity during 2009-2012, approving 23 proposals, a CalPERS staff report said last week.
During the three-year boom before the crash and the four-year period afterward, emerging managers received the same share of CalPERS equity commitments, 18 percent, said the staff report.
“Few other pension systems have commitments as significant as CalPERS does to emerging and diverse (minorities and women) managers,” said the staff report. “As of June 2012, private equity had a total of $14.8 billion committed to emerging managers and $5.9 billion committed to diverse managers.”
Last February CalSTRS asked a consultant that evaluated its emerging manager program in real estate in 2011 to do the same for private equity, examining the 23-year history of the CalPERS emerging manager private equity program.
“There is an absence of compelling evidence that emerging managers consistently outperform or underperform more established managers,” Crosswater Realty Advisors said in a report last week.
The CalPERS board approved plans to give emerging managers more information, perhaps with a human touch, when they apply for funds and a more detailed explanation if denied.
A task force will look at a dozen case studies to see if there are ways to identify successful managers. And CalPERS will hold a forum or workshop for emerging managers next April, similar to one last December.
At CalSTRS, the two trade associations have not made complaints. A spokesman said two CalSTRS officials have received awards from the associations, and others have appeared on panels or made addresses at association conferences.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at Calpensions.com.