5 Bigger Problems Than Placement Agents

In the wake of New York’s kickback scandal, public pension funds have been bending over backwards to declare their independence from placement agents. Some new policies have been reasonable (see CalPERS), while others have been reactionary (see New York City and New York State). Overall, however, they’ve been diversionary.

Simply put, placement agents are well down on the list of things that are wrong with public pension systems, vis-à-vis their investments in private equity. Here are five more destructive issues – none of which are being publicly addressed by elected officials or their mouthpieces.

1. Politicians

There is no greater source of corruption in public pension systems than the elected/appointed officials charged with being those systems’ fiduciary. Not just Treasurers and Comptrollers, but also Trustees and other such officeholders. I’m not saying they’re all rotten, but far more of these people have taken kickbacks than have private equity portfolio managers.

Some of the kickbacks are Hank Morris-esque, while the majority come in the form of campaign donations or other favors. All of them, though, result in downward pressure on PE portfolio managers to pay special attention to certain investment prospects.

“When I took over [State Pension System X],” one former manager told me, “I was informed that I was responsible for 80% of our private equity investments. When I asked about the other 20%, I was told not to worry about it.” I’ve heard that same story repeated over and over, sometimes with the percentages flipped.

2. Staff Turnover/Compensation

It’s a big deal when an insitution like Harvard or Yale loses its head of private equity. When it happens at a public pension fund, everyone just shrugs their shoulders. “Of course they left,” people say, “The money’s better elsewhere, and your boss doesn’t change every four years.”

Investment staff turnover at public pensions results in a shortening of institutional memory, a lengthening of decision-making and a general instability that can give a general partner pause. But few public pension seem willing or able to do much about it. There’s obviously no way to alter the electoral system, but a solid case could be made for raising salaries and prioritizing the filling of open positions. You’ve got to spend money to make money, and investment offices are the one part of state and municipal government that is expressly designed to make money.

It’s great that NYC Comptroller William Thompson said on CNBC yesterday that he wants to “beef up” his internal investment staff, but why has he let his “managing director of private markets” job stay unfilled for so long? And why are there still no job postings for those other (phantom?) positions, more than a week since the placement agent ban was put into effect? On the upside, I was able to find out that the City does have a “director of private markets.” Her name is Liz Caldas. For some reason, Thompson’s press office doesn’t know who she is.

3. Emphasis on Local Investment

Want to drive down investment returns? Allocate a portion of your portfolio to be invested locally, whether or not there are adequate investment opportunities. It can sometimes work for a system like CalPERS — thanks to the presence of Silicon Valley — but it’s usually a PR coup that becomes a balance sheet nightmare (remember the Ohio Bureau of Workers Comp carveout? Ouch!).

And this isn’t just anecdotal. Josh Lerner of Harvard Business School once published a paper that found a “negative proximity effect” when it came to limited partner commitments to general partners. If you expect your private equity portfolio managers to double as economic development pros, then you’re likely to be disappointed.

4. Over-Reliance on Outside Consultants

A lot of public pension systems either outsource all of their private equity investment matters, or a healthy portion of them.

This is understandable (refer back to #2), but also can pose even worse problems than can placement agents. After all, wasn’t Aldus Equity a discretionary consultant for New York Common Retirement System? You know, the same Aldus that is now the subject of criminal charges.

I’m not arguing for a ban on consultants — any more than I’d argue for one on placement agents — but public pension systems should demand much more transaparency from their hired gatekeepers. Not just internally, but externally. Don’t just tell me that Consultant A recommended a particular fund. Tell us why, and how the relationship originally began and progressed. If it turns out that the consultant lied about the timeline or rationale, fire them.

5. Inadequate Overall Transparency

Six years ago, the University of Texas Investment Management Co. (UTIMCO) decided to begin publishing fund-specific performance data for its private equity managers. CalPERS and CalSTRS followed suit (after fighting it in court). At the time, certain private equity wags suggested that these institutions would be given the cold shoulder by secrecy-obsessed general partners, thus reducing the pension systems’ ability to access top funds.

It is true that certain GPs bailed (venture firm Sequoia Capital, most notably), but it has mostly had a negligible effect. In that spirit, let’s get as much info out there as possible. Tell us how fund investments were sourced, why the investment is being made, how it fits into an overall allocation strategy, etc. We get some of this from a few pension systems, but most keep their mouths shut. and even the few that release full returns data are typically tardy updating their numbers.

If you keep everything in the dark, don’t be surprised when something goes bump.