CalPERS Private Equity Investment Returns on Course for Serious Deterioration

Two years ago it was said that you if had a direct line to the CIO of CalPERS, one of the nation's largest public pension funds, and specifically to its Alternative Investment Management group, you had it made. None of that Goldman Sachs partners being masters of the universe garbage - this was the real deal.

Say you needed $100 million for fund XYZ - you simply dialed that one number in Sacramento, and if you made it past the secretary, you were golden. Of course, this worked best if your name started with Leon and ended with Black, but other managers were also sitting pretty. The reason for this is that unlike the public pension funds of New York State for example, where the bulk of the investments were in the public markets via an internal asset manager (who was pretty horrible at his job judging by the fund IRR), and only occasionally did NY invest in external private and public fund managers (which more often than not included a variety of kickbacks, bribes, and other illegal schemes as recently reported by NY's own Andrew Cuomo), CalPERS has the bulk of its assets invested in 3rd parties.

While Thomson Banker gives the total amount of CalPERS public investments at $38 billion, an obscure site within the CalPERS website labyrinth presents the amount allocated and invested in various 3rd parties. And the amount is staggering: it seems that a vast number, maybe even a majority of U.S. private equity firms, owe their existence to CalPERS.

Here are the facts (as of September 30, 2008):

• Number of unique investments: 290
• Total Capital committed: $53.2 billion
• Cash Invested: $30.8 billion
• Cash Distributed: $17.4 billion
• Cash Distributed Including "Residual" Value: $38.8 billion

It is that last number which we will focus on shortly...

But some more data first.

CalPERS had $173.6 billion in total assets at March 26, which represents a loss of 26.6% after costs between July 1, 2008 and January 31, 2009. The full January 31 CalPERS asset summary can be found here.

Additionally, CalPERS seems to be suffering from the book-to-market marking syphilis that is pervasive throughout Wall Street: book value of CalPERS' assets was $194.9 billion at January 31, a non-trivial $21.3 billion overestimation of its market value. We would venture to guess which of these two numbers is used for pension actuarial purposes, but the answer is likely quite obvious. Interestingly, in the same report, the value of AIM investments had a $27.4 billion book value, and an even worse $23.9 billion market value. While I am not sure how this number compares to the $38.8 listed above as total investments plus cash outs, or the $21.4 billion of net (38.8-17.4) AIM value at September 30. However, if the superficial conclusion is that the market value of private equity investments between September 30 and January 31 increased by $2.5 billion, then we may have some very serious credibility issues on our hands.

Here is what CalPERS says about its Alternative Investment Management program:

Since inception in 1990 to September 30, 2008, the Alternative Investment Management (AIM) Program has generated $14.2 billion in profits for CalPERS. Given the young, weighted-average age of the portfolio (3.2 years) this amount will continue to grow as the portfolio matures.

CalPERS may need to adjust this mission statement once the December 31 numbers are out.

But continuing with the facts. Here are the asset managers that have benefited the most from CalPERS generosity, based on both total capital committed and actual cash invested (this is not an exhaustive list of CalPERS investments).

Apollo: $4.1 billion, $2.7 billion

Aurora: $650 million, $267 million

Avenue: $1.4 billion, $780 million

Blackstone: $1.4 billion, $1.2 billion

Candover: $643 million, $480 million

Carlyle: $4 billion, $2.1 billion

CVC: $2.3 billion, $1.3 billion

First Reserve Fund: $1.1 billion, $685 million

Leonard Green: $850 million, $455 million

Hellman & Friedman: $1.0 billion, $762 million

KKR: $1.6 billion, $880 million

Levine Leichtman: $450 million, $389 million

Lexington Capital: $400 million, $392 million

Madison Dearborn: $710 million, $634 million

MHR: $400 million, $218 million

New Mountain: $550 million, $165 million

Oak Hill: $375 million, $151 million

Pacific Corporate Group: $1.9 billion, $800 million

Permira: $573 million, $388 million

Providence: $525 million, $297 million

Silver Lake: $1.1 billion, $450 million

Tommy Lee: $640 million, $475 million

Tower Brook: $575 million, $220 million

TPG: $3.2 billion, $1.5 billion

Wayzata: $325 million, $218 million

Welsh Carson: $650 million, $601 million

WLR: $698 million, $405 million

Yucaipa: $764 million, $481 million

And many others... But you get the gist: Apollo, Carlyle, TPG, CVC, Silver Lake, Blackstone, and Avenue pretty much hold the fate of the majority of California's teachers and public workers in their hands... And that future is looking really, really ugly.

We dig in: Among the other data, presented on the CalPERS AIM page is the public IRR disclosed per fund. This is probably the best indication of how some of the more troubled private equity firms are gaming the system, and massively misrepresenting actual results.

We randomly picked as a case study the Apollo Investment Fund VI L.P., which CalPERS has committed $650 million to, actually invested $508 million into, withdrawn $10.9 million from and present the residual value (including the withdrawn amount) as $450 million, or a -10.7% IRR. Now we don't have reason to believe that CalPERS is fudging this number: after all it is reporting merely what Apollo is telling it.

So the next question is, is this -10.7% IRR indicative of the investments in Apollo VI?

The names that constitute the $10.2 billion in committed capital Apollo VI are:

Realogy (H) (on verge of bankruptcy)

Harrah's (HET) (on verge of bankruptcy)

Claire's (CLE) (on verge of bankruptcy)

The debacle that was the Huntsman LBO

Rexnord (RXN)

Berry Plastics (BRY)

Verso (bankrupt)

Jacuzzi Brands (JJZ)

etc.

We highly doubt -10.7% is anything even remotely close to where CalPERS should consider its residual equity value in Apollo VI. And by fair estimates, this is merely the tip of the iceberg.

Nonetheless, presenting public data that shows that the public pensions manager is disclosing over $14 billion in profits when it is hiding potentially much more than that in losses could be interpreted as borderline illegal. The question is, is this a responsibility of Apollo (to show the true sad state of affairs), or of CalPERS (to actually check these numbers and not to pull a Fairfield Greenwich "sorry, we had no clue what was really going on until it was too late").

Regardless, as CalPERS itself points out, the numbers were as of September 30. It is a fact, that the December 31 numbers are due any minute and we are salivating at the prospect of feasting our eyes on these numbers, to see just how disconnected from reality the column known as IRR as presented by CalPERS has become.

And just as Apollo VI is merely the tip of the asset manager iceberg, so is CalPERS merely a blip in the Alternative Investment Management universe of all public pension managers. Combined together, and based on realistic performance, these two will result in an explosive deterioration in both fund IRRs and public pensioners' patience and empathy, once they realize their money has been mismanaged into oblivion.

Comments

[ArkansasAngie:]

The BO Administration isn't really interested in sweeping under beds or beating the dust out of rugs. The clutter and trash would be staggering and would raise unwanted questions.

Pension funds had/have a fiduciary responsibility to take care of widows and orphans. They don't seem to have a done a very good job.

Because companies weren't adequately funding their funds, fund managers tried for higher and higher returns.

When yoy returns on staid pension funds average over 12% per year, year after year, that golden goose needs to be inspected. Strip the imaginary profits which created all too real bonuses and gee ... you get big time write downs.

You can be sued for negligence by would-be burglars who trip and fall on your property. But you can't do anything when your money is pissed away by negligence.

Heck ... these yahoos are getting retention bonuses instead of the boot.

Mar 30 08:34 AM

[MarkitWacha:]

Excellent article.

With the demographics of the baby boomer generation appearing (the pig in the python), it's likely that this pension fund and others like it will make headlines soon.

I wouldn't be surprised to see money thrown at these soon in the form of some kind of bailout. I think this will happen because the senior citizens have a voting majority.

Pension fund managers across the country have been exaggerating their expectations for years. To those who rely on pensions and are reading this: don't.

Mar 30 08:55 AM

[User 345491:]

Pension fund managers don't get bonuses for performance, as far as I know, still they get recognition and better career prospects (in politics usually).


On Mar 30 08:34 AM ArkansasAngie wrote:

> The BO Administration isn't really interested in sweeping under beds
> or beating the dust out of rugs. The clutter and trash would be staggering
> and would raise unwanted questions.
>
> Pension funds had/have a fiduciary responsibility to take care of
> widows and orphans. They don't seem to have a done a very good job.
>
>
> Because companies weren't adequately funding their funds, fund managers
> tried for higher and higher returns.
>
> When yoy returns on staid pension funds average over 12% per year,
> year after year, that golden goose needs to be inspected. Strip the
> imaginary profits which created all too real bonuses and gee ...
> you get big time write downs.
>
> You can be sued for negligence by would-be burglars who trip and
> fall on your property. But you can't do anything when your money
> is pissed away by negligence.
>
> Heck ... these yahoos are getting retention bonuses instead of the
> boot.

Mar 30 09:01 AM

[spope33:]

One minor detail, California teachers are not (mostly) in Calpers, they are in the separate, approximately as large Cal STRS

Mar 30 04:47 PM

[Fighting Yoda:]

Alternate Investment thesis is finished (like subprime investing). The investments are illiquid and market prices very hard to determine. These did well during the boom ‘cause there was a greater fool. Everyone is trying to get out of these including the big endowments (like Harvard etc), they have lost very big like Calpers.

Mar 30 10:50 PM

[Old Trader:]

A good and interesting piece that serves to confirm my presently bearish disposition. I seem to recall having read that if California was a separate country, it's economy would the 9th largest in the world. This does NOT bode well for the US, going forward, and the whole pension shortfall "shoe" will be dropping soon enough. Consider what will happen to corporate earnings, when those already paltry earnings will need to be "dipped into" to enable pension funds to meet their obligations.

Mar 31 07:16 PM

[Charles Gar...:]

Ok, this is all very surprising coming from Tyler Durden whose posts are normally on the money. There are two elements which make his statment that "Apollo, Carlyle, TPG, CVC, Silver Lake, Blackstone, and Avenue pretty much hold the fate of the majority of California's teachers and public workers in their hands... And that future is looking really, really ugly" just a bunch of unfounded sensationalism.

First, the funds provided to these alternative assets are dwarfed by those put into the public equity markets by CalPERS. Looking at the report linked to above, the Alternative Assets have a market value of USD 24bn compared to USD112bn for the traditional stocks and bonds. Overall, CalPERS has put 14% of the funds entrusted to it into Alt Assets (Private Equity, Venture, Hedge Funds).

But if you look at the hit the hit they are taking on the 40% of funds they have invested in stock markets, you see right away that the fate of California's teachers are not in the hands of Appollo, KKR and Co. In fact, from the same document Tyler posted, you see that while CalPERS relies 100% on outside managers like Apollo for investing 14% of the fund in Alt Assets, it relies mostly on its own people to invest in the stock and bond markets. The fate of California's teachers are somewhat in the hands of the overpaid PE guys, but it is mostly in the hands of CalPERS (or in the invisible hands of the market, which ever you prefer to blame).

The second reason Tyler is shooting a bit left of center on this one is that Private Equity is an illiquid and long-term asset class. (Hedge funds are not, but it looks like CalPERS is not too deep in those). The Apollo fund cited was raised in 2005 and so it is still in the early stage. The investments made may be teetering on bankruptcy or worst, but they have six more years before they have to be sold off (most funds are for 10 years).

Yes, the year end numbers are going to be ugly, and the negative IRR is going to get worst on this and other funds. But Apollo is not selling. It has a few years to decide what to do, to hope and prey things turn around, etc.

If CalPERS decides to sell its interest in Apollo's fund right now, yes, there will be a loss to the good educators of California, but nothing compared to the other losses they would take if they existed many of their equity positions.

And to hopefully nip this sensationalism in the bud, CalPERS is one of the most aggressive Pension Funds when it comes to investing in private equity. They have a goal of keeping around 10% of the fund in PE whereas most Pension Funds are around 5%. But, CalPERS is considered a leader and a lot of the public pension funds (not to mention private endowments and asset managers) are planning to increase their allocation to PE in the years that come. Why? Because PE outperforms the market (in theory). A lot of pension funds realize that if they are going to make up the funding gaps in the road ahead, they need investments that do better than 4-5% in fixed income or (choose your stock market premium)% in stocks. PE is supposed to provide that.

But the point is not whether the bad guys are Apollo or CalPERS (or the other monkeys who were paid more than they deserved). The point is that the gloom and doom is starting to feed on itself which is the only reason I can think for why T.D. totally struck out on his latest at bat.

Apr 01 03:55 PM