Wednesday, September 2, 2009

The Cost of Doing Business?


The WSJ's Private Equity Beat reports that NY Comptroller Releases Data On A Handful Of PE Funds:

New York State Common Retirement Fund, the place where the pay-to-play scandal now sweeping the nation originated, has released performance data on 12 funds named in Securities and Exchange Commission and New York Attorney General documents related to the scandal.

State Comptroller Thomas DiNapoli says that the pension fund continues to evaluate its options, fund by fund, on investments made during the era of his predecessor, Alan Hevesi. He also says the release of the data supports his goal of making the Common Retirement Fund “the most transparent and accountable public pension fund in the nation.” DiNapoli said in June, when he discussed March quarter results on a conference call, that legal counsel advised against releasing fund-level data at that point.

The system has yet to release its Comprehensive Annual Financial Report for its most recent fiscal year. That report typically includes fund-level information for all of its private equity partnerships. The system does not disclose quarterly performance data as many of its peers do; nor does it disclose net internal rates of return, a key measure of private equity performance.

The figures released by DiNapoli today do little to settle the question of whether or not funds that are tied up in the pay-to-play scandal are performing worse than funds that aren’t; the performance of the funds is a mixed bag, and many of the vehicles listed are too young to judge just yet.

It’s worth noting that one of the two funds associated with Carlyle Group and Riverstone Holdings LLC - both of which have settled their involvement in the scandal by agreeing to pay fines - is doing quite well. Carlyle/Riverstone Global Energy Fund II, a 2003 fund, was valued as of March 31 at $363.6 million versus capital contributed of $163.1 million. Its follow-up, raised in 2005, is also hanging in there, valued at $355.4 million, versus capital contributed of $324 million.

Aldus/NY Emerging Fund, a 2004 fund affiliated with Aldus Equity Partners, a firm that faces charges related to the scandal, is also modestly in the black. The Common Retirement Fund values it at $253.4 million versus capital contributed of $247.3 million. Since the Aldus/NY Emerging Fund is a fund of funds, its capital gets drawn down more slowly than the direct funds, so its performance may not be directly comparable to direct commitments like Carlyle’s.

DiNapoli emphasized that just because a fund is included on the document released today doesn’t mean it has engaged in potential misconduct. Some of the funds that are listed in Securities and Exchange Commission and New York Attorney General complaints related to the pay-to-play investigation - Falconhead Capital Partners II and Pequot Private Equity IV, for example - are not included here, because those investments were made via the funds of funds that are listed on the report.

Reuters reports that NY probe-linked pension investments lost money:

New York state's $116 billion pension fund lost money on five of 12 of the private equity investments cited in federal and state corruption probes, the state comptroller said on Wednesday.

The losers were GKM Newport/NY Venture Capital; the Sector Performance Fund; Paladin Homeland Security (NY); Quadrangle Capital Partners II; and Strategic Co-Investment Partners, according to the release posted on the web site: click here

The site also lists the winners, which include the Carlyle/Riverstone Energy Fund II.

The funds' performance is as of March 31 this year.

Democratic Comptroller Thomas DiNapoli in a statement said the firms' performance was made public "in the interest of transparency and not as an indication of potential misconduct."

State Attorney General Andrew Cuomo has said millions of dollars of kickbacks paid by investment firms eager to manage the state's retirement fund hurt the public by raising "the cost of doing business."

The dirty little secret in the pension world is that kickbacks are more common than people think in the private markets and hedge funds where funds try to bribe underpaid pension fund managers. How do I know? Because I have been approached in the past (very subtle, using words like 'facilitate') and witnessed my fair share of shady deals across many pension funds where I asked myself why the heck is this pension fund manager so gun-ho on that fund?

The problem with kickbacks is even though you know they're happening, it's very hard to prove because pension fund managers know how to cover their tracks. This is why I believe every major public pension fund should adopt a comprehensive fraud policy which protects whistle-blowers and is reviewed annually by certified fraud examiners.

It makes me sick to my stomach seeing pension fund managers getting greased by private funds - and thankfully it's not pervasive - but denying this problem exists just leaves the door open to more abuse.

Finally, please bear in mind the Mother of all scams has nothing to do with pay-to-play, but everything to do with bogus benchmarks in alternative investments. As if this isn't bad enough, I heard of one pension fund that was massively short stocks since early March, has decided to retroactively change its weighting in equities (from underweight to market weight) and private markets (from overweight to underweight) so that its results do not look as bad going forward.

If true, that's what you call outright fraud.

***UPDATE***

The Albany Business Review reports that pension fund increase could lead to local tax hikes:

Today, DiNapoli announced larger pension bills for municipalities that will come due in 2011. By law, he is required to give advanced notice of new rates.

Average contribution rates for the majority of government employees will rise from next year’s rate of 7.4 percent of salary to 11.9 percent of salary in 2011. The average rates for the police and fire pension system will rise from 15.1 percent next year to 18.2 percent in 2011.

DiNapoli said the global recession is driving the pension rates higher.

“There is no question that it’s been hit by the crumbling economy,” DiNapoli said of the state pension fund. “When the markets perform poorly, the rates have to increase.”

The state pension fund lost $44 billion of its value from spring 2008 to spring 2009, dropping almost 30 percent to a value of $109.9 billion. The fund had a negative return rate of 26.3 percent for the state’s 2008-09 fiscal year, which ended in March.

Today, the fund is valued at $116.5 billion. New York’s pension fund is the third-biggest in the nation, behind two in California.

Get ready for more contribution rate increases and higher property taxes. The pension tsunami is just beginning and its devastation will be felt for many more years.

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