The pension and the placement agent

Two things happened earlier this month that seemed almost symbolic of some larger truth.

First, former placement agent Al Villalobos, 71, apparently shot and killed himself in a Nevada gun range. Villalobos had been awaiting trial for alleged fraud in connection with his private equity fundraising work for investment managers like Apollo Global Management trying to secure commitments from the California Public Employees’ Retirement System. Villalobos was a former CalPERS board member who went off on his own and formed a placement agency.

Second, the Financial Times published an article with CalPERS Chief Investment Officer Ted Eliopoulos in which the CIO said CalPERS was working to cut down the number of private equity managers in its portfolio. Eliopoulos also said CalPERS would try and work with other limited partners to push back on fees, according to the article.

The connection between these events is that – prior to the start of Villalobos’ legal troubles around 2009 – you might say CalPERS was basking in the glow of private equity’s Golden Era. The largest pension system in the United States was the major LP in private equity. CalPERS was the benchmark, its actions were closely watched in the industry, and it could make or break GPs. It seeded the creation of several new firms.

That Golden Era came to an end with the global financial crisis. And as history has repeatedly shown, once the market collapses, bad behavior is suddenly revealed.

CalPERS began to reverse direction after the financial crisis, which coincided with the gradual revelation of alleged bad behavior on the part of Villalobos and others. CalPERS former chief executive Federico Buenrostro was accused alongside Villalobos of a scheme to defraud the retirement system. Buenrostro later pleaded guilty to accepting bribes from Villalobos.

Far from dishing out the most money in private equity, the retirement system essentially froze its commitment activity and looked inward, performing internal investigations into potential corruption in its investment program.

After exhaustive investigations, CalPERS established various rules to try to protect the system, including stronger regulation of interactions with placement agents. CalPERS also extracted fee breaks from several of its existing private equity managers, including Apollo.

In the ensuing years, CalPERS reduced its allocation target to the asset class to 10 percent, which required commitment pacing of about $6 billion a year to achieve. That bears repeating: $6 billion a year in commitments to private equity funds.

Now, the FT article has set tongues wagging that CalPERS is cutting back its private equity program. Several articles have connected this CalPERS decision with its announcement last year that it would completely divest its $4 billion hedge fund portfolio.

Some perspective is needed.

Most importantly, the FT revelation was not new information, though it was interesting coming directly from Eliopoulos. But CalPERS has been trimming down its private equity portfolio for some time.

In fact, the system has made use of the secondary market to sell large chunks of its portfolio.

What the system is doing is paring down the number of relationships it has to manage, sticking only with what it considers “core” managers. This is routine practice among public pension systems and something every private equity LP should at the very least have under consideration.

As far as I can tell, this has nothing to do with the system bailing out of alternative investments. Rather, this is all about rebalancing one of the largest private equity portfolios in the industry.

It’s a smart move, especially in today’s environment when secondary buyers are paying top prices for LP interests.

CalPERS will continue to be a major backer of private equity funds, only it’s arguably being more selective about where it parks its money, and on what terms (compared to the Golden Era). The system, under the private equity leadership of Real Desrochers, has been one of the more vocal negotiators for lower fees and better fund terms from GPs.

The truly significant revelation in the FT piece is that Eliopoulos said the system would seek to work with other investors to push for lower fees. CalPERS would carry a lot of weight in any coordinated effort to reduce fees and provide more transparency around private equity funds.

Then, of course, the specter of LP collusion starts to emerge. But that’s a story for another time.

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