Private equity is complicated. General partners know it, as do the investment staffers tasked with shepherding fund commitments through pension investment meetings.
Retirement system trustees, on the other hand, may not have as sophisticated an understanding of the asset class. This knowledge gap can lead to misunderstandings, confusion and — if the fight over California’s PE transparency bill is any indication — intense disagreements between board members and staff regarding which information is relevant to public investors.
“In almost every case I have encountered, the trustees are dedicated, thoughtful people who are legitimately trying to do the best for the public employees of the state,” wrote Harvard Business School Professor Josh Lerner in an email to Buyouts. “But the investment world is a complex and frequently opaque one, and in many cases, the trustees have ‘day jobs’ which are far removed from investment management.”
Institutions looking to narrow that gap should take a cue from Lerner and Washington State Investment Board. Earlier this summer, the $106.9 billion retirement system brought in Lerner to give a presentation covering the nuances of private equity, including fee and fund structures. He also put board members through the paces of manager selection and return considerations, pairing his instructional programming with interactive scenarios.
In one, board members took on the role of an investment staffer who must choose between re-upping with a current, underperforming GP or forming a new relationship with an up-and-coming PE firm with less of a track record.
“I think it gave the board a realistic view of … what are the questions we need to be asking? How should we interpret staff’s reports on things like key-person risks?” Washington spokesman Chris Phillips told Buyouts. “How would you approach that? From a risk point of view, what do you do? What do you decide to do?”
Those questions address cracks inherent to the investment process and whether other relevant points should be considered. Prior to making a new fund commitment, public-pension investment staffers scout new opportunities and allocation schemes, conduct due diligence (often with paid consultants), then present potential investments to their board of trustees for approval.
When the fund finally comes before the board, information originally provided by general partners may have been distilled, repackaged or tossed aside by staff.
Filtering out certain information is necessary — it would be unrealistic for board members to conduct on-the-ground assessments of each GP.
Unfortunately, along the way, trustees become disconnected from the choices and opportunity costs that staff weigh before making their investment recommendations.
This is important because as more pensions confront concerns from beneficiaries over investment-related fees, trustees need to be in a position to ask pertinent questions about their investment recommendations. Not to antagonize staff but to make them better stewards of retirement-fund assets. Educational programs like those Lerner offered put them in a better position to do so.
“I think the takeaway is: The board will deepen their understanding. It gave them more avenues to ask questions,” Phillips said. “They’re in a position where they can ask about the integrity of the organization [and] how decisions were made.”
Harvard University Professor Josh Lerner speaking at PartnerConnect East, which included VCJ‘s annual East Coast conference Venture Alpha East, on April 6, 2016, at the Hyatt Regency in Boston. Photo by Alastair Goldfisher, Venture Capital Journal
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