Wednesday, April 30, 2014

Hiding Private Equity Details?

David M. Toll of Reuters PE Hub reports, NY Teachers’ shows off double-digit PE gains; won’t reveal details:
The New York State Teachers’ Retirement System will tell you that its private equity portfolio has generated a net IRR of 11.1 percent through the end of June 2013. But don’t ask for the details. The pension fund believes that the returns of individual funds are trade secrets, according to sister publication Buyouts.

Responding to an open-records act request by Buyouts earlier this year, New York State Teachers’ did provide some insights as to where its returns are coming from. Since inception through June 30, U.S. buyout funds, which account for about half of the private equity portfolio by market value, led the way with a 13.6 percent IRR and 1.5x investment multiple, according to documents provided by the pension fund.

That is followed by U.S. special situations funds (19 percent by market value) with a 12.8 percent IRR and 1.4x investment multiple; and international funds (17 percent of market value) with a 10.0 percent IRR and 1.4x investment multiple. Venture capital, representing 13 percent by market value, lagged in last place with a 3.9 percent IRR and 1.2x investment multiple.

The documents portray a large and active private equity program at the roughly $95 billion pension fund. As of Sept. 30, New York State Teachers’ had a $7.4 billion private equity portfolio consisting of commitments to 168 limited partnerships managed by 79 buyout and venture capital firms. Sponsors backed more than once by the pension fund include ABRY Partners, The Carlyle Group, Hellman & Friedman, Silver Lake and TPG Capital.

The state pension fund’s recent pace of commitments has been accelerating. Through Sept. 30, the pension fund had $15.9 billion in outstanding commitments, up from $14.9 billion at year-end 2012, suggesting it had made fresh commitments of $1 billion through the first nine months of last year, according to the documents. In 2012 the pension fund committed an estimated $1.6 billion, way up from an estimated $900 million in 2011 and $200 million in 2010.

But when it comes to individual funds, the pension fund draws the line at providing basic information such as the name of each limited partnership, the amount committed and the amount drawn down. In its February open-records request, Buyouts asked for IRRs and investment multiples for each partnership, along with management fees. The pension fund responded that those numbers were off limits. It cited a provision of the state’s open-records act that lets it deny requests of information that “would if disclosed impair present or imminent contract awards” and “are trade secrets …”

In our appeal of that decision, we pointed out that sister state pension funds such as the Teachers’ Retirement System of the City of New York have been disclosing such details about their funds “with no apparent ill effects” on the general partners.

But Kevin Schaefer, the records appeals officer for the pension fund, wasn’t convinced. In his March 6 reply by letter, he denied our appeal. He went through six factors used to determine whether information is a trade secret immune from disclosure. The first, he wrote, is “the extent to which the information is known outside the business.”

Buyouts possesses similar information—IRRs and investment multiples, for example—for several funds that are backed by New York State Teachers’ because they are also backed by New York City Teachers’; among them are The Blackstone Group’s fourth and fifth funds. Schaefer did not view our argument through the same lens. The information made public by New York City Teachers’, he wrote, “is specific” to that pension fund and not New York State Teachers’.

The second factor was similar to the first, while the third of six factors, Schaefer wrote, is “the extent of measures taken by a business to guard the secrecy of the information.” Buyouts possesses detailed fund information on hundreds of limited partnerships disclosed by sponsors via their pension backers around the country.

But again, Schaefer did not see it this way. “General partners of funds,” he wrote, “take measures to ensure the confidentiality of their investment strategy and fund level performance by providing it only to investors and customarily under confidentiality obligations.” At press time a spokesperson for New York State Teachers’ added in an email that ”the NYS and NYC are separate and distinct organizations which, among other differences, include separately negotiated investment agreements with potentially unique rights, obligations and liabilities—including those governing confidentiality requirements and the protection of trade secrets.”

Our request fell short on the other three factors as well.

Buyouts hasn’t decided whether to continue the battle. It should be obvious by now that no harm results from disclosing fund return data, which has been available from pension funds like the California Public Employees’ Retirement System for years following lawsuits early last decade by the San Jose Mercury News.

Put aside for the moment that I am a journalist who likes reporting on juicy return data. Is it wise to hide from New York State Teachers’ Retirement System pensioners—including both my parents—how individual money managers are performing, and how much they’re charging?

A recent Bloomberg story reported that the U.S. Securities and Exchange Commission has found that dozens of private equity firms are inflating portfolio-company fees without notifying investors. If true, I would argue that this industry needs to open its books even further, not less.
I've already covered bogus private equity fees as well as CalPERS' legal battle with blogger Yves Smith of Naked Capitalism. It seems like large public pension funds are public as long as it suits their needs, or more likely, those of their big and powerful private equity partners who basically run the show via the political back channels.

Commenting on this latest pathetic display of withholding information from the public, Yves Smith of Naked Capitalism says NY Teachers' exhibits Stockholm Syndrome:
Readers may find it hard to grasp how successful the private equity industry has been in brainwashing investors, particularly large public pension funds. Investors who ought to have clout by virtue of their individual and collective bargaining power instead cower at the mere suggestion of taking steps that might inconvenience the private equity funds in which they invest.
Poor Yves, despite the name of her blog, she still doesn't get what capitalism is all about. Even Thomas Piketty, whose popular book on how capitalism has failed the world, doesn't get it. Two guys that do get it are Shimshon Bichler and Jonathan Nitzan who just published their latest, The Enlightened Capitalist, a letter answering the critique of a large asset manager.

Capitalism, my dear readers, isn't about openness, fairness, transparency and meritocracy. Capitalism is all about crisis, sabotage, secrecy and how the elite can screw the unsuspecting masses using any means necessary, ensuring inequality which they require to thrive. 

The pension Ponzi is all about how a few powerful hedge funds and private equity funds can ensure their growth by capturing a larger slice of that big, fat public pension pie. They use all sorts of slick marketing, talk up the virtues of diversification and absolute returns, but for the most part, it's all hogwash, all part of Wall Street's secret pension swindle.

I know, I'm being way too cynical. Some pension fund manager is going to write me an angry email telling me how private equity and real estate are the best asset classes and how I'm misrepresenting the benefits of alternative investments in a pension portfolio. I'm not an idiot. I know there are great hedge funds and private equity funds but the reality is the bulk of alternative funds are nothing more than glorified asset gatherers raping public pension funds with outrageous fees.

The question now becomes why are public pension funds and more importantly, private equity funds, not providing more details on their fees and fund investments? Are they complete and utter fools? If they want to win the public relations war in an era of social media, they better hop on the transparency and accountability bandwagon fast!

And by the way, things are far from perfect in the private equity world. Biggest Buyout Gone Bust in Energy Future Dims Megadeals:
The failure of Energy Future Holdings Corp., known as TXU Corp. when KKR & Co., TPG Capital and Goldman Sachs Capital Partners acquired it for $48 billion in 2007, and the stumbles of other huge deals of the past decade have reshaped how major buyout firms go about their trade.

The Dallas-based utility’s bankruptcy yesterday ended the biggest leveraged buyout on record and will wipe out most of the $8.3 billion of equity that investors led by three of the world’s largest private-equity firms sank into the company.

“Energy Future is emblematic of the peak of the buyout boom, when firms did very high-priced, over-leveraged deals that left little room for error,” said Steven Kaplan, professor at the University of Chicago Booth School of Business. “When you buy into a cyclical industry at the peak and you get the bet wrong, bad things happen.”

TXU marked the climax of an era when buyouts stretched into the tens of billions on dollars and Carlyle Group LP’s David Rubenstein predicted there would be a $100 billion LBO. After many of those deals faltered in the 2007-2009 global financial crisis, private-equity investors mostly shied away from companies valued at $20 billion and up, arguing that such buyouts are often overpriced, overburdened with debt and too big to exit easily.

Since the end of 2008, two private-equity buyouts priced above $20 billion have been announced, both in 2013. That compares with 15 in the five years through 2007, according to data compiled by Bloomberg. TPG told investors last year that its next fund will largely stay away from the biggest buyouts, according to a person who attended the firm’s annual meeting in October.
Debt Markets

Three private-equity executives interviewed for this story said they didn’t expect a revival of super-sized buyouts any time soon. The executives asked not to be named because they didn’t want to be seen as criticizing competitors.

Large companies such as Energy Future tend to put themselves up for sale at times when debt markets are wide open and deal valuations are high, said two of the executives.

Those conditions in 2007 set the stage for a buyout that loaded Energy Future with $40 billion of debt, or 8.2 times the company’s adjusted earnings before interest, taxes, depreciation and amortization, a common yardstick for leverage. By contrast, debt averaged 5.3 times Ebitda for all U.S. buyouts in 2013, according to Standard & Poor’s Capital IQ. In the end, the debt combined with a collapse of natural gas prices, to which Energy Future’s revenues are pegged, toppled the company.

The biggest buyout funds have lagged behind smaller competitors in recent years, according to London-based research firm Preqin Ltd. Funds of $4.5 billion or more from the 2008 vintage posted median net internal rates of return of 7.8 percent through 2012, compared with 9.3 percent for pools of $501 million to $1.5 billion, the firm’s latest data show.

Of the megadeals announced before 2008, some have turned profits, such as those of hospital owner HCA Holdings Inc., energy pipeline operator Kinder Morgan Inc. and British retailer Alliance Boots GmbH. Others, including casino operator Caesars Entertainment Corp., broadcaster Clear Channel Communications Inc. and credit-card processor First Data Corp., have struggled with weak earnings and heavy debt.

“If you assembled all the mega-cap deals, you would have a poor-performing portfolio,” said Steven D. Smith, managing partner at Los Angeles-based private-equity firm Aurora Resurgence and a former global head of leveraged finance at UBS AG.
Kinder Morgan

Kinder Morgan produced a gain of 180 percent for Carlyle and other backers. At Caesars, Apollo Global Management LLC’s investment has tumbled about 57 percent in value, based on the April 28 closing price.

“The core of what’s wrong with many of these mega-cap deals is that they got priced to perfection,” Smith said. “In this world nothing is ever perfect, and so there are surprises.”

Megadeals can be difficult for investors to cash out of, resulting in longer holding periods and less than stellar returns, said John Coyle, a partner at Permira Advisers LLP, a London-based private-equity firm with more than $30 billion in assets. Many of the targets are too big to sell to another corporation or private-equity group, making the only path to an exit a sale of stock in an initial public offering.

“If you elect to go the IPO route, public equity investors won’t forget that you paid a premium in the bull market of 2006 to 2007,” Coyle said. “They know your exit options are limited, and therefore, with exception for only the rarest of assets, they have the pricing power.”
Valuations Fall

For years it was the fallout of the financial crisis, rather than a reconsideration of deal-making practices on the part of private-equity firms, that put a halt to the biggest deals. Debt financing for LBOs all but evaporated in 2008, when speculative-grade corporate loan issuance in the U.S. fell to $157 billion from a then-record $535 billion in 2007, according to S&P’s Capital IQ. It wasn’t until November 2011 that a corporate buyout once again topped $7 billion in size.

Large company deal valuations fell from the boom-era median of 12.7 times Ebitda to 8.6 for the nine largest corporate buyouts completed from 2009 to 2012, according to data compiled by Bloomberg. The proportion of equity to debt jumped to almost one-to-one in deals such as TPG’s and Canada Pension Plan Investment Board’s $5.2 billion purchase in 2010 of health-care data provider IMS Health Inc. and 2012’s $7.15 billion buyout of oil and gas driller EP Energy by Apollo Global and others.
Investor Pressure

Revived markets have eased the credit drought, as speculative-grade loan issuance rebounded to $605 billion last year, when banks pulled together debt packages for $24 billion-plus LBOs of computer maker Dell Inc. and foods group H.J. Heinz Co. Debt markets have rallied so strongly that $15 billion to $20 billion loan and bond packages for LBOs are possible, said one of the private-equity executives.

Even as lenders have opened their purses, buyout firms continue to apply the brakes to jumbo deals. The executives interviewed for this story, whose firms backed megadeals in the heyday, said some limited partners have urged them to steer clear because of their checkered results.

Limited partners, the pension systems and other financial institutions that supply the money buyout firms invest, have curbed commitments to buyout funds raised since 2009, shrinking sponsors’ capital. Buyout fundraising fell to a post-crisis low of $77.5 billion in 2011 from $229.6 billion in 2008, according to Preqin. Last year, $169 billion was gathered.
Multiple Managers

Clients have also pressed firms to avoid banding together with two or more competitors to raise the billions of dollars of equity that the biggest buyouts demand. It was only by pooling money, as KKR, TPG and Goldman Sachs did in the Energy Future deal, that firms were able to pull off the largest LBOs.

The consortium-backed deals left limited partners that had money with several of the firms with added risk in a single deal. Last year’s $24.9 billion Dell buyout skirted that issue because company founder Michael Dell provided most of the equity, with a single buyout firm, Silver Lake Management LLC, furnishing the rest.

“Limited partners don’t enjoy paying multiple managers fees to be invested in the same underlying companies,” said Jay Rose, a partner at StepStone Group LP, a San Diego, California-based pension-fund adviser.
Fundraising Woes

TPG, which is preparing to raise a new buyout fund this year, told limited partners at its annual meeting last year that it will avoid megadeals unless an opportunity is exceptional, according to an investor who attended. The firm plans to go back to investing in upper middle-market deals with smaller equity contributions, this client said. The firm also said that group deals largely are a relic of the past, according to the person.

The focus on smaller deals also reflects a tougher fundraising environment since the financial crisis. Like many of its peers, TPG expects to raise a smaller fund than the prior vehicle, which gathered $19.8 billion in commitments in 2008. Fund VI, which was 85 percent invested at the end of September, is on a path to run out of capital by mid-to-late 2014, based on the current investment pace, said another investor who attended the annual meeting. TPG this year sought as much as $2 billion from its largest investors to bridge the gap until it starts marketing its main fund.

Despite the obstacles, megadeals have come back before.
‘Short’ Memories

KKR’s $31.3 billion takeover of RJR Nabisco in 1989, by far the largest buyout of its era, barely escaped bankruptcy in 1990 and dealt KKR a loss of about $816 million on its $3.6 billion equity investment, according to a confidential KKR marketing document obtained by Bloomberg News. Not long after that transaction closed, the economy slumped, debt markets fell into disarray and it wasn’t until 2006, when KKR and others bought HCA, that a deal of similar size was struck.

“Even though most firms say they won’t pursue mega-buyouts, in the private-equity industry memories can be short and some just can’t help themselves,” said David Fann, president and CEO of TorreyCove Capital Partners LLC, a San Diego-based pension-fund adviser.
Indeed, in the private equity and hedge fund industry memories are short, which is why when the next crisis hits, a lot of public pension funds taking on too much illiquidity risk, praying for an alternatives miracle, are going to get clobbered. And even then, they still won't reveal details of their alternative investments. This is why I keep harping on pension governance and real transparency and accountability.

Below, Private Equity Growth Capital Council CEO Steve Judge discusses the SEC probes of private equity firms on Bloomberg Television's “Market Makers.” Notice how this guy avoids answering questions directly on private equity's bogus fees, skirting the issue and singing the same marketing tune on how "private equity is the best asset class for pensions, endowments and foundations."

Tuesday, April 29, 2014

Leo de Bever Leaving AIMCo?

Gary Lamphier of the Edmonton Journal reports, AIMCo to replace CEO Leo de Bever:
Alberta’s big public sector pension fund manager is in the hunt for a new boss.

Alberta Investment Management Corp. (AIMCo) announced Friday it has launched a search for a new CEO to replace its current chief, Leo de Bever.

The 65-year-old has guided AIMCo since it was spun off by the province as a crown corporation in 2008.

“Executive succession for an organization is an important fiduciary responsibility for both the board and the CEO,” AIMCo said in a news release. “AIMCo has been focusing on this initiative for a number of months and ... will now be proceeding with a search process for our next CEO to ensure a new leader is in place to guide the organization into the next phase of its evolution.”

AIMCo said de Bever will continue in the role as CEO while the search process is underway.

“I’m now the oldest CEO in the pension industry in Canada,” said de Bever, whose blue-chip resume includes stints at the Ontario Teachers’ Pension Plan and Victorian Funds Management, one of Australia’s biggest pension funds.

“The board felt that they should start a CEO search because they want to make sure they have someone in place for the next five or 10 years. In the meantime, I’m in place and it’s business as usual.”

On Wednesday, AIMCo announced that it generated a 12.5 per cent net return for 2013 and a 14 per cent return on its balanced funds, marking the best results in its history.
I covered AIMCo's 2013 results here. aiCIO also reports, AIMCo to Replace CEO de Bever:
The Alberta Investment Management Corporation (AIMCo) is launching a search for a new chief executive to replace founding CEO Leo de Bever.

AIMCo "will undertake a comprehensive and diligent process, and will take the full time necessary to identify and secure AIMCo’s next CEO,” the sovereign wealth fund has announced.

De Bever has led the fund to strong performance for several years, adding $23 billion in total return since its inception. Charles Baille, chair of AIMCo’s board of directors, called him “the driving force behind many of our successes.” De Bever, he said, had "created a high performing investment organization of which Albertans can be proud.”

He joined the organization in 2008 at its first CEO. The Alberta government created AIMCo as a Crown Corporation to professionalize the management of its sovereign wealth and pension assets, primarily.

“The Crown Corporation set-up allowed me to hire people and compensate them on a commercial basis, at one-third to one-fifth of the cost of doing things externally,” de Bever told aiCIO in 2012.

In the announcement, he said, "a critical part of the CEO’s job is to effectively pass the torch to the next generation of leadership.”

However, the CEO drew public criticism and the eye of regulators for his role at now-defunct real estate firm First Leaside Group. The Ontario-based investment group raised more than $330 million—largely from retail investors—but began seeking creditor protection in 2012, according to Morningstar.

De Bever served as a founding partner of First Leaside in addition to his duties at AIMCo. An archived version of his biography from the firm’s website touted his “extensive experience in managing and evaluating risk.”

The Ontario Securities Commission pursued a case against two other First Leaside executives, alleging that one of the founders “intentionally deceived investors" by selling assets without informing them that the company’s viability had been called into question by an accounting review.

De Bever was not charged with any wrongdoing.

The statement of his pending resignation made no mention of the First Leaside situation.

De Bever spent much of his career at the Bank of Canada, and served nearly ten years as a senior vice-president of the Ontario Teachers’ Pension Plan. Prior to joining AIMCo, de Bever led the Victorian Funds Management Corporation in Melbourne, Australia.
There is no doubt about it, Leo de Bever is a giant in the pension fund world. He has battle scars going back from his days at Ontario Teachers where he ran the risk department. He came to AIMCo in August 2008 after a brief stint in Australia, lowered fees paid to external managers and was able to attract and retain talent in Edmonton, no easy feat.

I had the pleasure of meeting and speaking with Leo a few times. He is unquestionably one of the smartest and nicest people in the industry. In fact, he's brilliant. He has a PhD in Economics and reads continuously on all subjects. If you sit down with him, you'll be amazed at the breadth and depth of his knowledge.

In 2010, Leo warned my readers of what will happen when the music stops. That was one of my best interviews on this blog. Leo covered risks in bonds, stocks, hedge funds and private markets in that discussion. In June 2011, he discussed rearranging the chairs on the Titanic, where he shared his skepticism on the Fed's quantitative easing (QE) policy in regards to improving the real economy.

In May 2012, Leo called the top in the bond market and warned of storm clouds ahead, a controversial call which helped AIMCo last year. Nevertheless, despite the bond panic of 2013, I remain more worried about deflation than inflation and think bonds are far from dead.

The one thing that struck me about Leo is that he's worried about many things but always remains optimistic. In fact, Leo de Bever is always imagining a better future and has access to the most senior policymakers in Ottawa.

So why is Leo stepping down? I don't think First Leaside played any role and it is a minor blemish in an otherwise spectacular career (the aiCIO article is factually incorrect). I honestly think Leo is tired. He looked tired when I first met him at PSP back in 2006. He has been battling politicians in Alberta who don't understand how important it is to properly compensate pension fund managers and how hard it is to add value over public market benchmarks.

And let me be clear on something, Leo de Bever is properly compensated and he knows it. But his compensation pales in comparison to the outrageous compensation they doled out for PSP Investments' senior managers last year. I initially defended PSP's hefty payouts but then came to my senses and saw that PSP's tricky balancing act is all about screwing around with their bogus benchmarks so they can dole out huge bonuses to their senior managers in good and terrible years. Not to mention that PSP is based in Montreal so getting millions in total compensation is literally winning the lottery every year!

Let me be clear on something else. Even though I defend compensation at Canada's public pension funds, I think a lot of people on the buy side are way overpaid for the supposed risks they take. I have doctors in my family and group of friends who truly bust their ass working crazy hours and they don't get compensated anywhere near what these senior pension fund managers get. Admittedly, most people in finance are way overpaid but it's a joke and compensation needs to be reined in.

Lastly, I will express some disappointment that Leo and some of his counterparts at Canada's large public pension funds have not subscribed to my blog to help support my work. Nobody owes me anything but their financial support is appreciated.

Below, Warren Buffett discusses Coke's frothy pay plan which Berkshire abstained from voting on (but sent a strong signal to Coke's management). I wonder what the Oracle of Omaha would say about the frothy pay plans at some of Canada's largest public pension funds.

Monday, April 28, 2014

Consultants Eating Up Funds of Funds?

Joshua Franklin and Simon Jessop of Reuters report, Fund of hedge funds face fight for cash with consultants:
Funds that invest in a range of hedge funds are facing a battle to win new business, as the same consultants they court to win money from pension firms are grabbing a chunk of an industry that was already struggling to grow.

So-called fund of hedge funds are designed to give investors an easy way of putting money into hedge funds, offering to spread their risks and do research into the individual hedge funds for them.

But sliding asset prices during the financial crisis and the fallout of the Bernie Madoff fraud scandal saw billions of dollars exit fund of hedge funds, leading many to close or merge.

Over the past few years, those that remain have found consultants - who have built up expertise after years of vetting fund of hedge funds for institutions - are now investing directly into funds on behalf of some large-scale clients.

Trade publication InvestHedge found three consultants - Mercer, Cambridge Associates and Towers Watson - were among the 10 biggest fund of hedge funds by assets as of the end of 2013, representing 12.6 percent of the $728 billion held by fund of hedge funds with assets worth at least $1 billion.

"In new allocations to the industry ... consultants are active in gaining mandates," said Joachim Gottschalk, chairman and chief executive of hedge fund firm Gottex.

The increased competition is particularly significant, because the industry is struggling to grow.

The value of assets held by fund of hedge funds worth at least $1 billion has risen by just 16.5 percent since 2009, according to InvestHedge, and remains well below the peak of just over $1 trillion hit in 2007.

The hedge fund industry on the other hand is booming - total assets under management are at historic highs after rising by almost two thirds over the same period, data from industry tracker HFR showed.

Fund of hedge funds have voiced concerns over a potential conflict of interest in cases where they pitch strategies to consultants that are also in competition with them.

But consultants argue they have internal measures to prevent the sharing of confidential information.

"Those individuals responsible for researching hedge fund of funds and the research they conduct is Chinese walled off from the rest of the business," said Dan Melley, UK head of fiduciary management at Mercer.


Fund of hedge funds have traditionally relied on high net-worth individuals. But in recent years, institutional investors have become a bigger part of the industry's client base, handing an advantage to consultants, many of which have long relationships with pension funds and other institutions.

Deutsche Bank's Alternative Investment 2014 Survey found the proportion of respondents from the fund of fund industry - of which fund of hedge funds are a part - who said more than half of their assets under management in 2013 came from institutions was 63 percent, up from 53 percent in 2008.

Many fund of hedge funds have adjusted to the new landscape, increasing the services they offer instead of simply selling fund of hedge fund portfolios.

"Before it was very formatted," said Nicolas Rousselet, managing director at Swiss investor Unigestion. "They had fund of funds or direct hedge funds ... Now it's much broader."

Many fund of hedge funds now provide co-management services for investors looking to play a more active role in their portfolio, fiduciary services for clients who want to keep their investments at arm's length, and advisory offerings for clients investing directly.

This has made the traditional fund of fund compensation structure - a 1 percent management fee and a 10 percent performance fee - a thing of the past.

"Increasingly any fund of fund that has any institutional business is in effect changed into a consulting firm," said Peter Douglas, founder of Singapore-based hedge fund consultancy GFIA.

"The idea that any capital owning institution is going to pay 1+10 for a commingled portfolio of hedge funds is yesterday's story."
In December 2008, I warned that funds of hedge funds face extinction. Fast forward to 2014 and we see why. Not only are funds of funds not able to charge that extra layer of fees, they now face increasing competition from useless investment consultants that are marketing geniuses able to bamboozle their clients into believing pretty much anything.

However, while most funds of hedge funds are struggling, the largest firms in the stricken industry keep getting larger. The top 50 firms in Institutional Investor's Alpha annual Fund of Funds 50 ranking control some $494 billion combined, and the top 10 of those firms manage $224 billion:
That’s no accident, if there is any truth to the old maxim that it takes money to make money. The top firms, like No. 1-ranked Blackstone Alternative Asset Management, have the cash to branch out into newer, more lucrative areas beyond the traditional funds-of-funds model of investing in hedge funds on behalf of clients. This once-hot strategy has suffered significantly since the financial crisis of 2008, when funds of funds lost money and clients fled en masse. Now, cutting-edge funds-of-funds firms are getting into areas such as staking hedge fund firms with start-up capital and offering supervisory services for institutional investors who want to invest in hedge funds directly but still need a guiding hand.

These moves, while innovative, cost money and require connections — two things that many smaller firms do not have in abundance. With more and more institutional investors looking to go it alone, firms that have the money to innovate are best placed to survive the new climate.
If I had a choice to go with a Blackstone or a Mercer, I would definitely choose the former and sign an air-tight co-management agreement with them to train my internal staff so they can invest directly. That's what a very smart guy like Rick Dahl, CIO at MOSERS, did when  he started investing in hedge funds. He needed a reputable fund of hedge funds to get into the space but he also wanted to train his small staff to become good at direct hedge fund investing.

As far as consultants getting into this space, it's fraught with potential conflicts of interests. Consultants are branching out into fund investments because they realize that their traditional (low margin) business model is dead and the real money is in asset gathering. Everyone wants to collect fees through asset gathering but the problem is there is no alignment of interests and the focus isn't on performance where it should always be.

One area where funds of hedge funds still dominate is in seeding new hedge funds. They have the network and expertise to identify talented managers and seed the funds with the highest probability of success. Even here they face stiff competition from hedge fund gurus like Julian Robertson whose accelerator fund is burning bright (but that is not a seed fund).

I'm actually amazed that hedge fund inflows are booming. Despite hedge funds having suffered the worst performance start to the year since 2011, industry assets hit a new peak of $2.7 trillion thanks to healthy net inflows. And who is leading the charge? Who else? Dumb public pension funds getting raped on fees, ignoring the hedge fund curse.

Below, Troy Gayeski, senior portfolio manager at Skybridge Capital, talks with Tom Keene about asset allocation and market risk for hedge fund managers in “This Matters Now” on Bloomberg Television’s “Bloomberg Surveillance.”

Friday, April 25, 2014

Wall Street's Secret Pension Swindle?

David Sirota of Salon reports on Wall Street’s secret pension swindle:
In the national debate over what to do about public pension shortfalls, here’s something you may not know: The texts of the agreements signed between those pension funds and financial firms are almost always secret. Yes, that’s right. Although they are public pensions that taxpayers contribute to and that public officials oversee, the exact terms of the financial deals being engineered in the public’s name and with public money are typically not available to you, the taxpayer.

To understand why that should be cause for concern, ponder some possibilities as they relate to pension deals with hedge funds, private equity partnerships and other so-called “alternative investments.” For example, it is possible that the secret terms of such agreements could allow other private individuals in the same investments to negotiate preferential terms for themselves, meaning public employees’ pension money enriches those private investors. It is also possible that the secret terms of the agreements create the heads-Wall-Street-wins, tails-pensions-lose effect — the one whereby retirees’ money is subjected to huge risks, yet financial firms’ profits are guaranteed regardless of returns.

North Carolina exemplifies the latter problem. In a new report for the union representing that state’s public employees, former Securities and Exchange Commission investigator Ted Siedle documents how secrecy is allowing financial firms to bilk the Teachers’ and State Employees’ Retirement System, which is the seventh largest public pension fund in America.

The first part of Siedle’s report evaluates the secrecy.

“Today, TSERS assets are directly invested in approximately 300 funds and indirectly in hundreds more underlying funds, the names, investment practices, portfolio holdings, investment performances, fees, expenses, regulation, trading and custodian banking arrangements of which are largely unknown to stakeholders, the State Auditor and, indeed, to even the (State) Treasurer and her staff,” he reports. “As a result of the lack of transparency and accountability at TSERS, it is virtually impossible for stakeholders to know the answers to questions as fundamental as who is managing the money, what is it invested in and where is it?”

Before you claim this is just a minor problem, consider some numbers. According to Siedle’s report, this huge pension system now is authorized to invest up to 35 percent — or $30 billion — of its assets in alternatives. Consider, too, that Siedle’s report shows that with such a large allocation in these risky alternatives, the fund “has underperformed the average public plan by $6.8 billion.”

So what is happening to retirees’ money? As Siedle documents, more and more of it is going to pay the exorbitant fees charged by the Wall Street firms managing the pension money.

“Fees have skyrocketed over 1,000 percent since 2000 and have almost doubled since (2008) from $217 million to $416 million,” he writes, adding that “annual fees and expenses will amount to approximately $1 billion in the near future.”

The details get worse from there, which makes Siedle’s report a genuine must-read for anyone who wants to understand the larger story of public pensions. After all, North Carolina is not an isolated incident. In state after state, the financial industry is citing modest public pension shortfalls to justify pushing those pensions to invest more money in riskier and riskier high-fee investments — and to do so in secret.

It is a story that isn’t some minor issue. On the contrary, the fight over that $3 trillion is fast becoming one of the most important economic, business and political stories of modern times. The only question is whether the story can even be told — or whether those profiting off secrecy can continue hiding their schemes from the public.
Ted Siedle, aka the pension proctologist, wrote another excellent article for Forbes, North Carolina Pension's Secretive Alternative Investment Gamble:
The need for regulatory intervention by the U.S. Securities and Exchange Commission in the North Carolina state pension alternative investment stand-off between the State Treasurer and her deep-pocketed Wall Street allies, on the one hand, and the stakeholders committed to safeguarding the $87 billion pension, on the other, cannot be overstated. The same situation exists at countless other public pensions around the nation, in states such as Illinois, Kentucky, Rhode Island and South Carolina. At stake is nothing less than the fiscal viability of state and local governments across the country, as well as state employees’ retirement security.

The following is a summary of a 147-page forensic investigative report of the North Carolina pension which was filed with the SEC this week. My firm, Benchmark Financial Services, Inc. was retained by the State Employees Association of North Carolina, SEIU Local 2008, to conduct this preliminary review. Benchmark identified widespread potential violations of law within the pension which we believe should be investigated by the SEC, Internal Revenue Service and law enforcement.

Janet Cowell is neither the first North Carolina State Treasurer to abuse her power as sole fiduciary of the state pension nor, absent radical structural reform, will she be the last. Pay-for-play has long been a problem in the state’s pension system. For more than a decade state treasurers have handed out billions of dollars in public assets to money management and other firms that contribute to their political campaigns.

Cowell has taken this quid pro quo to a new level as the Teachers’ and State Employees’ Retirement System of the State of North Carolina (“TSERS”) has grown to $87 billion and disclosed fees paid to Wall Street have skyrocketed 1,000 percent. Cowell’s political manipulation of the state pension fund has cost North Carolina $6.8 billion in fees and lost investment opportunities during her tenure.

The unchecked ability to steer tens of billions in workers’ retirement savings into hundreds of the highest-cost hedge, private equity, venture and real estate funds ever devised by Wall Street, in exchange for political contributions to her campaign and to the campaigns of other influential politicians, makes the Treasurer today arguably the state’s most powerful elected official.

The profound lack of transparency related to these risky so-called “alternative” investments provides investment managers ample opportunities to charge excessive fees, carry out transactions on behalf of the pension on unfavorable terms, misuse assets, or even steal them outright. Worse still, the Treasurer has betrayed her fiduciary duty by entering into expansive agreements with Wall Street to keep the very details of their abuse of pension assets secret — including withholding information regarding grave potential violations of law.

Kickbacks, self-dealing, fraud, tax evasion and outright theft may be designated as confidential pursuant to the North Carolina Trade Secrets Protection Act, says the Treasurer.

On a more granular level, Cowell’s efforts to thwart disclosure have helped mask potential violations including, but not limited to the following: fraudulent representations related to the performance of alternative investments; concealment and intentional understatement of $400 million in annual alternative investment fees and expenses to date; concealment of approximately $180 million in placement agent compensation; the charging of bogus private equity fees; violations of securities broker-dealer registration requirements related to private equity transaction fees; securities and tax law violations regarding investment management fee waivers and monitoring fees; self-dealing involving alternative investment managers; mystery investor liquidity and information preferences, amounting to licenses to steal from TSERS; pension investment consultant conflicts of interest; predatory lending and life settlement related fraud.

Further, the Treasurer has invested billions of dollars of pension assets in North Carolina private equity funds and companies via an initiative with dubious economic prospects and which has the markings of political influence-peddling.

In our opinion, billions in TSERS investments can only be explained by the improper collateral benefits they provide to the Treasurer — as opposed to any supposed investment merit.

Absent reform, corruption of TSERS is likely to cost the state’s public workers and taxpayers billions more over the next few years and leave in place a system under which Cowell’s successors will compound the financial damage.

Today, TSERS assets are directly invested in approximately 300 funds and indirectly in hundreds more underlying funds (through fund of funds), the names, investment practices, portfolio holdings, investment performances, fees, expenses, regulation, trading and custodian banking arrangements of which are largely unknown to stakeholders, the State Auditor and, indeed, to even the Treasurer and her staff.

As a result of the lack of transparency and accountability at TSERS, it is virtually impossible for stakeholders to know the answers to questions as fundamental as who is managing the money, what is it invested in and where is it?

It is indisputable that TSERS’ disclosed investment management costs alone (i.e., not including the enormous hidden costs revealed in this report) have skyrocketed in recent years and are projected by the Treasurer to steeply climb. Investment risk has grown to a record crisis level. Performance of hedge funds, private equity and real estate alternative investments has been beyond bad — horrific — for over a decade. Pay-for-play and transparency reforms promised by the Treasurer have failed, year after year, to materialize — despite multiple costly expert reviews paid for by the pension.

Worse still, the Treasurer has refused to comply with a new state law, which specifically requires full disclosure of all direct and indirect pension investment management and placement agent fees.

Treasurer’s Lack of Transparency

Forensic investigations of pensions require access to evidence. Contrary to initial public statements by the Treasurer indicating a willingness to cooperate with our investigation, she has made conducting this review of potential violations of law on behalf of TSERS stakeholders far more difficult by withholding the overwhelming majority of the information we requested.

Throughout her tenure, the Treasurer has stated repeatedly in public that she is committed to transparency. In contrast, she has proved unwilling to disclose to the public even the minimum pension information required under state law. Further, her office has, in our opinion, released information regarding TSERS to the public that has often been left intentionally incomplete and made deliberately misleading.

It is also notable that the Treasurer has failed to disclose certain significant investment manager fee and performance data that even her oft-criticized predecessor, Richard Moore, had voluntarily provided.

All of the financial information we requested in connection with this investigation was readily available to Cowell and her staff and of obvious materiality to TSERS participants, taxpayers and investors.

Perhaps most disturbing, in response to our specific requests the Treasurer refused to disclose offering memorandum and other key documents (including information regarding millions in placement agent fees) related to TSERS’ costly, high-risk alternative investments, citing supposed “trade secret” concerns raised by the alternative managers.

Viewed from a regulatory and public policy perspective, the Treasurer’s practice of withholding relevant information and intentionally providing incomplete or inaccurate disclosures regarding TSERS investments results in: (1) concealing potential violations of state and federal laws, such as those detailed throughout this report; (2) misleading the public as to fundamental investment matters, such as the true costs, risks, practices and investment performance related to hedge, private equity, venture and real estate alternative investment funds; (3) understating the costs and risks related to TSERS investments specifically; (4) misrepresenting the investment performance and financial condition of the state pension to investors in state obligations.

As stated on the website of the SEC:

“The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.”

On the other hand, when state officials and pension funds, such as the Treasurer and TSERS, intentionally withhold or misrepresent basic facts regarding investments material to evaluating investments, the pool of knowledge all investors can rely upon becomes contaminated.

In our opinion, there is simply no reason participants in TSERS who rely upon the investment decisions made by the Treasurer for their retirement security, and other stakeholders, should be provided with unreliable investment information — afforded less protection under the state and federal securities laws — than investors in shares of public companies and mutual funds.

Nation’s Seventh Largest Public Pension Has No Audited Financials

Remarkably, there are no audited financial statements for TSERS, the seventh largest public pension in the nation. We are unaware of any other public pension that completely lacks financial statements audited by either an independent accounting firm or the State Auditor, or both. This represents a major material weakness in the State of North Carolina Comprehensive Annual Financial Report (“CAFR”) which is relied upon by ratings agencies, municipal bond holders and the federal government in providing assistance to states.

In our opinion the lack of audited financial statements for TSERS is indefensible. The limited financial information regarding TSERS which the State Auditor claims to have audited and which is included in the voluminous 300-page CAFR, is of minimal value and is almost certainly incomprehensible to stakeholders.

We found no evidence in the CAFR or elsewhere to suggest that the Treasurer or State Auditor is even aware of the myriad new risks facing TSERS, much less begun to focus upon the emerging critical issues related to alternative investments.

In our opinion, a stand-alone audit of TSERS which would improve oversight and management of pension investments, reveal deficiencies (including fraud and other malfeasance), and produce savings exponentially greater than any limited audit cost, is decades overdue.

Notably, Treasurer Cowell has expressed the opposite view, stating that a separate audit of TSERS would be cost-prohibitive.

We find this assertion to be absurd and recommend that the scope of any future stand-alone audit include responses to the specific stakeholder concerns we have identified in this report.

Treasurer’s Government Operations Reports Violate State Law

As required under relevant law, on a quarterly basis the Treasurer provides a report to the Joint Legislative Commission on Government Operations on the investment activities of the State Treasurer, including TSERS.

In our opinion, given the disorganization, misstatements and omissions therein, there is simply no way that the Joint Legislative Commission on Government Operations, or anyone else for that matter, could possibly monitor or evaluate TSERS investment activity and performance from the information included in these reports.

The incomplete performance information provided in the discussion and other sections in the Government Operations reports results in concealing significant underperformance against the relevant indexes that would be readily apparent if complete performance information were provided in the initial narrative section.

Effective August 2013, state law mandates full disclosure of all direct and indirect investment management and placement agent fees in the Treasurer’s Government Operations reports. Cowell has failed to supplement the Government Operations reports with the newly required information.

In connection with our forensic investigation, on March 17, 2014, we reported the Treasurer’s violations of this law to State Auditor Beth Wood and asked that her office immediately investigate.

A History of Pay-for-Play Abuses

Allegations of improper pay-for-play payments by money managers and other vendors retained by TSERS first emerged in 2005 and were the subject of an early 2007 Forbes article titled “Pensions, Pols, Payola.”

In 2009, the state’s chief pension investment officer was reportedly terminated for soliciting donations on behalf of a local charity. In 2012, campaign donations to Cowell from plaintiff class action and other law firms retained by TSERS surfaced.

Further, recent disclosures by the Treasurer confirm that at least since 2002, TSERS investment managers have been involved in another form of pay-for-play, i.e., paying tens of millions in compensation to influential secret placement agents that may not be properly registered under the federal securities laws.

The identity of all of the placement agents, their registration status and the amounts of the compensation paid, while known to the Treasurer, remain undisclosed to this day — despite repeated recommendations from investment and legal experts retained by the Treasurer to fully disclose them, and in violation of the new state law which mandates disclosure.

As discussed further below, we estimate a staggering $180 million in avoidable fees has been secretly squandered in payments to dispensable intermediaries for conflicted, unreliable investment advice.

Flawed Sole Fiduciary Governance Structure

The Treasurer is the sole fiduciary of TSERS funds. Along with Connecticut, Michigan, and New York, North Carolina is one of only four states with a “sole fiduciary” model for managing its public pensions.

All other states vest the fiduciary duty to oversee their retirement assets in a committee generally consisting of worker and retiree representatives, state officials and appointed members of the public, as opposed to a single individual.

There is longstanding, broad national consensus that the sole fiduciary structure is deeply flawed.

In January 2014, the Treasurer announced the creation of a supposedly independent, bipartisan commission (consisting of members hand-picked by her) to review the state’s governance structure for investment management. The Treasurer has retained the consulting firm of Hewitt EnnisKnupp-an Aon Company to provide supposedly independent, objective advice to the commission.

In our opinion, it is indisputable that elimination of the sole fiduciary structure should have been the premier priority once the Treasurer Cowell took office given the long history of abuses involving the Treasurer’s office. However, replacing it (as at least one of Cowell’s advisors has recommended), with an investment committee comprised of experienced investment professionals operating in secrecy — an arrangement riddled with potential conflicts of interest, utterly lacking transparency and accountability — is outrageous and blatantly disingenuous.
Public pension reform and secrecy are, in our opinion, fundamentally incompatible.Further, we believe the initial matters any such committee should immediately focus upon are the secrecy surrounding alternative investments and placement agents; hundreds of millions in undisclosed fees; the serious potential violations of law detailed in this report and, finally, the Treasurer’s motivations and actions related thereto.

TSERS’ Escalating High-Risk Alternative Investment Gamble
TSERS’ escalating historic high-risk alternative investment gamble began over a decade ago in 2001. Allegations of impropriety relate back to inception of the failed strategy. Despite recurring controversies and allegations of corruption surrounding the former and current state treasurers over the years, as well as intermittent reports of dismal performance, the state pension has continued to dramatically increase its allocation to alternatives from 0.1 percent to 35 percent today, adding tens of billions to these costly schemes that have been disastrous for TSERS.

Most often, the past and current Treasurer’s justification for increasing alternatives has been the greater returns alternative investments offer—returns that repeatedly have failed to materialize.

Treasurer’s “Experiment” Fails: A Decade of Soaring Fees to Wall Street Has Not Improved Performance

Early on in her tenure, the Treasurer defended shifting more and more pension assets to costly alternative managers, arguing that the hundreds of millions in additional fees to Wall Street would result in improved investment performance.

“We’ll be looking for if we’re paying higher fees for investments they better be performing and giving us a higher rate of return. Otherwise, it’s a failed experiment,” Cowell said.

The Treasurer’s candid admission that the TSERS historic high-risk gamble on alternative investments amounting to 35 percent of $87 billion, or over $30 billion, is an “experiment” is startling. The Treasurer should not be experimenting with tens of billions in state workers retirement savings; rather, as the sole fiduciary, she should be focused upon investing pension assets prudently.

However, even as of this date in 2010, the costly alternative investment experiment had already spectacularly failed — it had been severely underperforming for approximately eight years.

The Treasurer stated in 2010 that the “experiment is on a seven-to-ten-year cycle, and performance and fees will be weighed over that time frame.”

Twelve years after inception in 2002, the alternative investment experiment continues to cost the pension dearly and benefits only Wall Street.

Most important, there is no proof that alternative investments beat the market, as the Treasurer has repeatedly represented to the public. Indeed, possibly the world’s greatest investor, the Oracle of Omaha, Warren Buffet, six years ago wagered $1 million that hedge funds would not beat the S&P 500 over the next ten years. At this point Buffet is still handily winning. The North Carolina state pension is not.

Billions in Underperformance to Date – Worst Yet to Come

In stark contrast to recent statements by the Treasurer that the additional investment flexibility granted by the legislature to permit TSERS to increase alternative investments will improve performance, the investment performance history clearly reveals that TSERS’ alternative investments and the pension as a whole have performed poorly.

Over the past five years, under the Treasurer’s watch, TSERS has underperformed the average public plan by $6.8 billion.
Based upon the TSERS investment track record, it is highly likely, in our opinion, that increasing the allocation to high-cost, high-risk alternative investments that have consistently underperformed will result in billions greater performance losses, as well as approximately $90 million in additional disclosed fees paid to Wall Street money managers according to the Treasurer’s estimates.While Wall Street is certain to emerge as a winner under the Treasurer’s politically-driven alternative investment gamble, the stakeholders will, in our opinion, lose ever greater amounts due to rapidly escalating fees and plummeting net investment performance.
The Myth That Alternative Investments Provide Diversification and Reduce Risk
The Treasurer’s argument that high-cost, high-risk alternative funds reduce risk or provide diversification is deeply flawed. Since many of the alternative investment managers may invest a substantial portion of a fund’s capital in a single investment and substantially, or even completely, change their investment strategies at any time, there is no way TSERS can ensure that the alternative funds provide any meaningful portfolio diversification.

Further, while the massive additional cost and underperformance of the alternatives at TSERS are apparent at this time, the amount of any potential downside protection afforded is unproven and unknown.

Thus, it is impossible for the Treasurer, consistent with her fiduciary duty, to determine that the known cost related to any supposed risk reduction is reasonable.

Massive Risk, Fiduciary Breaches and Violations of Law Revealed in Alternative Investment Documents

In order to assess the risks, potential fiduciary breaches and violations of law related to the hundreds of alternatives owned by TSERS, we reviewed the private placement offering memoranda related to certain of these investments.

A few of the offering documents we reviewed were provided by the Treasurer in response to our public records request. Other information the Treasurer refused to provide we obtained from independent sources, including the SEC.

The documents we reviewed indicate the alternatives are high-risk, speculative investments; the funds’ investments are highly illiquid subject to enormous valuation uncertainty; the offerings involve serious conflicts of interest regarding valuation of portfolios by the managers themselves and calculations of fees, as well as opportunities for self-dealing between the funds, the managing partners and their affiliates that may, in our opinion, violate state and federal law.

For example, a manager may make investments for his own account in the very same assets in which the fund he manages invests, on more favorable terms and at the expense of investors in the fund, including TSERS. Alternatively, in the event that an investment opportunity is available in limited amounts, the manager may simply seize the entire investment opportunity for himself — robbing investors in the fund he manages, in breach of applicable fiduciary duties.

Accordingly, we recommend further investigation by the SEC of such potential fiduciary breaches and violations of law.

Hedge and other alternative fund offering documents often reveal that investors, such as TSERS, are required to consent to managers withholding complete and timely disclosure of material information regarding the assets in their funds. Further, investors must agree to permit the investment managers to retain absolute discretion to provide certain mystery investors, i.e., industry insiders, with greater information and the managers are not required to disclose such arrangements to TSERS.

As a result, TSERS is at risk that other unknown investors in funds are profiting at its expense—stealing from the pension.

The identity of any mystery investors that may be permitted by managers to profit at TSERS’ expense, as well as any relationships between these investors, the Treasurer or other public officials, should be investigated fully by law enforcement and the SEC. Such arrangements amount to a license to steal from the state pension.

The alternative fund offering documents also generally provide that the funds will invest in portfolio companies that will not be identified to the investors prior to their investment in the fund. As a result, TSERS will not have any opportunity to evaluate for itself information regarding the investments in which the funds will invest. Since pension fiduciaries are required to know, as well as evaluate the assets in which they invest, in our opinion, such provisions render these investments unsuitable for fiduciary accounts.

TSERS alternative funds generally disclose a litany of risky investment strategies they may pursue such as short-selling; investing in restricted or illiquid securities in which valuation uncertainties may exist; unlimited leverage, as well as margin borrowing; options; derivatives; distressed and defaulted securities and structured finance securities.

Further, TSERS alternative investment documents reveal that managers may engage in potentially illegal investment practices, such as investing in loans that may violate the anti-predatory lending laws of “some states” and life settlement policies which give rise to lawsuits alleging fraud, misrepresentation and misconduct in connection with the origination of the loan or policy. In our opinion, an investigation should be undertaken by the SEC into the investment strategies of the alternative funds, as well as any underlying funds, to determine whether any violations of law exist.

Unlike traditional investments, the alternative funds in which TSERS may invest may be managed by investment advisers not registered with the SEC under the Investment Advisers Act of 1940. Further, the funds themselves are not registered as “investment companies” under the Investment Company Act of 1940. As a result, the limited partners lack many meaningful protections of those statutes.

There is no evidence the Treasurer, or the State Auditor, is aware of, or has ever considered, the unique risks related to the lack of these statutory protections.

Alternative investment funds that are incorporated and regulated under the laws of foreign countries, present additional, unique risks which pension fiduciaries must consider. Further, since TSERS’ alternative investment assets are held at different custodians located around the world, as opposed to being held by TSERS’ master custodian, the custodial risks are heightened and should be considered and disclosed to the public.

There is no evidence the Treasurer, or the State Auditor, is aware of, or has ever considered, the unique risks related to foreign regulation and custody of alternative funds. Further, based upon our conversations with the State Auditor, only the Treasurer knows whether the alternative investment funds are, in fact, audited annually — as represented in the state CAFR.

Our forensic investigation into specific potential violations of law we identified involving the hundreds of private equity investment funds in which TSERS invests was severely hampered by the Treasurer’s repeated refusal to provide the documents we requested.

In light of a recent internal review by the SEC indicating that more than half of approximately 400 private-equity firms the SEC staff examined charged unjustified fees and expenses without notifying investors, we requested documents related to such potential violations of the securities laws from the Treasurer. Our request was denied.

Accordingly, in our opinion, whether any of the hundreds of TSERS private equity funds have been charging “bogus” fees to portfolio companies in violation of the federal securities laws is a matter that should be referred to the SEC for further investigation, as well as potential refund to TSERS of its share of any fees improperly charged.

In light of recent SEC whistleblower allegations that private equity firms have been violating securities laws by charging transaction fees without first registering as broker-dealers with the SEC, we requested information regarding such potential violations of the securities laws from the Treasurer. Our request was denied.

Accordingly, in our opinion, whether any of the hundreds of TSERS private equity funds have been charging transactions fees in violation of the securities laws is a matter that should be referred to the North Carolina Secretary of State Securities Division and the SEC for further investigation, as well as potential refund to TSERS of its share of any transaction fees illegally charged.

In light of whistleblower claims that have been filed with the IRS alleging that hundreds of private equity so-called monitoring fees paid by private equity owned portfolio companies are being improperly characterized as tax-deductible business expenses (as opposed to dividends, which are not deductible), costing the federal government hundreds of millions of dollars annually in missed tax revenue, we requested information regarding such potential violations of federal tax law from the Treasurer. Our request was denied.

Based upon our preliminary research it appears that at least three monitoring agreements involving a single TSERS private equity fund may be suspect to re-characterization by the IRS.

Given the hundreds of other TSERS private equity fund investments and hundreds of suspect monitoring fees identified by credible whistleblowers, it seems virtually certain that additional violations of tax law exist with respect to TSERS private equity investments.

Accordingly, in our opinion, whether any of the hundreds of portfolio companies owned by TSERS private equity funds have been improperly characterizing monitoring fees as business expenses in violation of the Internal Revenue Code and costing the federal government hundreds of millions annually in tax revenue is a matter that should be referred to the IRS and SEC for further investigation.

Since the IRS in recent years has been examining the propriety of private equity management fees waivers, which have allowed many fund executives to reduce their taxes by converting ordinary fee income into capital gains taxed at substantially lower rates, costing the federal government billions of dollars annually in missed tax revenue, we requested information regarding potential violations of tax law related to these waivers from the Treasurer. Our request was denied.

Accordingly, in our opinion, whether any of the TSERS private equity funds have been complicit in allowing their managers to improperly convert ordinary fee income into capital gains is yet another matter that should be referred to the SEC and IRS for further investigation.

Treasurer Conceals Investment Fees Will Skyrocket to $1 Billion

While the Treasurer has a fiduciary duty to ensure that fees TSERS pays money managers for investment advisory services are reasonable, as well as a statutory duty to disclose all direct and indirect investment and placement agent fees, she has failed to monitor and disclose all fees paid by TSERS.

The Treasurer has withheld from public disclosure a massive portion of the fees and expenses related to alternative assets, resulting in the dramatic understatement of fees, expenses and risks related to these investments, as well as TSERS as a whole.

In a letter dated February 27, 2014, we notified Cowell that based upon our preliminary review of the limited information provided in response to SEANC’s public records request, it was apparent that the Treasurer had failed to disclose a significant portion of the hedge fund and alternative investment manager fees paid by TSERS to money managers. Indeed, it appeared that the massive hidden fees she failed to disclose in many instances dwarfed the excessive fees disclosed to us.

The limited investment fee information provided by the Treasurer indicates that disclosed fees have skyrocketed over 1,000 percent since 2000 and have almost doubled since FY 2008/2009 from $217 million to $416 million. In the past fiscal year alone, disclosed fees have climbed from $295 million to $416 million — a staggering increase of more than over 40 percent.

Worse still, according to Cowell, annual investment fees are projected to increase about 10 basis points—another almost $90 million—due to the allocation away from low-cost internally managed fixed income to high-cost, high-risk alternative funds managed by Wall Street.

In summary, the total investment fees as disclosed by the Treasurer are projected to climb to over $500 million.

Unlike traditional investments, such as stocks, bonds and mutual funds, alternative investments are opaque and subject to myriad hefty fees.

Based upon our limited review of TSERS’ investments, we estimate total undisclosed fees will comparably climb to approximately $500 million.

Thus, we estimate total TSERS annual fees and expenses will amount to approximately $1 billion in the near future — almost twice the figure projected and disclosed by the Treasurer.

The increase of disclosed fees in 2013 to $416 million, while alarming, is a gross and intentional understatement by the Treasurer, in support of her failed alternative investment strategy. In our opinion, if the magnitude of the formidable undisclosed fees related to TSERS alternative investments were acknowledged, public acceptance of the Treasurer’s high-risk, underperforming investment gamble would wane.

Past and Present Placement Agent Abuses at TSERS

While Treasurer Cowell publicly acknowledged the importance of adopting a pay-for-play and placement agent policy in 2009, disclosure has not meaningfully improved during her tenure. Further, her investigation of placement agent abuses has languished for the past five years. Placement agent controversies remain profoundly unresolved.

Rather than promote transparency and accountability regarding placement agent usage at TSERS, the record reveals that the Treasurer has intentionally withheld, as well as sought to thwart the release of, damning placement agent information since taking public office.

Cowell did not disclose to the public in May 2009, or at any time subsequent, that she had received a SEC Letter of Inquiry regarding placement agents at TSERS. Worse still, she requested that neither the cover letter nor any other documents provided by her in connection with the SEC Inquiry be released by the SEC to the public in response to a request under the federal Freedom of Information Act. Cowell even asked to be given at least ten days prior notice and an opportunity to object to the Commission to the granting of any Freedom of Information Act request and, if necessary, to seek an appropriate protective order in the courts.

Despite repeated requests from the SEC, the Treasurer failed to disclose even a single placement agent payment amount in 2009.

In April 2010, the consulting firm of EnnisKnupp retained by Cowell recommended that to promote transparency and accountability, details regarding placement agent compensation be posted on the Treasurer’s website for disclosure to the public.

While the Treasurer’s Office implemented certain of EnnisKnupp’s recommendations, it did not and still has not implemented this key recommendation regarding public disclosure of placement agent compensation called for by best practices, according to Ennis.

Worse still, the Placement Agent Policy adopted by the Treasurer in 2009 expressly permits an investment manager or placement agent to designate as a trade secret under North Carolina law the placement agent identity, services and compensation. Cowell has refused to disclose millions in TSERS placement agent payments, claiming trade secrets.

In 2013, the law firm of Kellogg, Huber, Hansen, Todd, Evans & Figel, P.L.L.C., hired by the Treasurer to review certain placement agent matters, in its Final Report called upon Cowell to disclose placement agent compensation amounts on the Treasurer’s website — as originally recommended in 2010 by EnnisKnupp and ignored by her for more than three years.

To date, the placement agent fee amounts paid by each TSERS manager and the total amount of placement agent compensation have not been disclosed to the public on the Treasurer’s website, or anywhere else.

The incomplete information provided to the public regarding placement agents on her website is so disorganized and unreliable that it can only confuse and mislead the public, in our opinion. Further, as a result of Cowell’s willingness to permit managers to designate certain placement agent fees as secret, the fees disclosed are obviously understated.

Assuming that the Treasurer has enforced compliance with the placement agent policy (which requires disclosure of the fees paid to her), the relevant information is readily-available — indeed already known to her.

According to statements attributed to the Treasurer, a staggering 50 percent of TSERS managers pay placement agent fees that range from 1 percent to 2 percent.

Our investigation reveals that TSERS placement agent percentages alone, in fact, range as high as 3 percent. In addition to the percentage fees, there are monthly retainers, expenses and discretionary bonuses included in the agent’s total compensation. We have not factored these amounts, which may be significant, in our estimate below.

It appears that for the past five years Cowell has intentionally withheld from public scrutiny arguably the most significant information regarding placement agent fees — the fact that TSERS has secretly squandered a staggering estimated $180 million in avoidable fees to dispensable intermediaries for conflicted, unreliable investment advice.

Due to the highly significant amounts secretly paid for questionable so-called investment services and the Treasurer’s apparent unwillingness to disclose such placement agent compensation amounts to stakeholders — even as required under state law — we recommend that further investigation by the SEC is needed at this time.

Dubious North Carolina Nexus Investments and Influence-Peddling

A significant portion of TSERS’s alternative investments, including but not limited to the North Carolina Innovation Fund and the other Credit Suisse/North Carolina funds, are invested in private equity funds and companies that are based in North Carolina. Both the current and prior Treasurer have/had policies giving preference to local funds and enterprises.

Pension policies targeting local businesses give rise to heightened concerns regarding potential improper relationships between locals and pension decision-makers that may result in imprudent investments.

In our opinion, many of the local private equity funds and companies in which TSERS has invested clearly lacked the requisite relevant experience and track records generally required by pensions. Not only did TSERS “seed” many of these funds and businesses apparently lacking merit, it continued to leave substantial assets at risk in them long after, in our opinion, it became apparent that their services were uncompetitive.

In our opinion, an investigation by law enforcement and the SEC into the facts and circumstances regarding many of the North Carolina nexus investments should be undertaken and would reveal imprudent decision-making based upon improper relationships, as well as outrageous profiteering.

Treasurer’s Heavy Reliance upon Troubled Credit Suisse

Clearly, Credit Suisse, a firm which has a significant presence in North Carolina in the form of 1,000 employees based in the Research Triangle Park has had a substantial, complex, secretive and highly lucrative relationship with both the current and past Treasurer. Due to the variety of investment services provided, the relationship is fraught with myriad potential conflicts of interest. Further, the firm’s management of investment funds that target North Carolina enterprises is a pivotal, potentially politically sensitive assignment.

In our opinion, in light of the TSERS’s longstanding heavy reliance upon Credit Suisse — a firm involved in numerous grave regulatory controversies globally at this time; the variety of services the firm provides and the myriad potential related conflicts of interest — further investigation of the relationship between the Treasurer, TSERS and the firm by the SEC is merited at this time.

We note that with respect to the majority of alternative investments made by TSERS where the investment managers involved have been permitted to designate the compensation arrangements involving millions of dollars they have entered into with placement agents as “trade secrets” under North Carolina law, Credit Suisse Securities is the named placement agent receiving the secret compensation.
Siedle's damning forensic report on North Carolina's pension is an eye opener for most people that are absolutely clueless of what really goes on at these large public pension funds. None of this surprises me as I've written on the secret pension money grab and North Carolina praying for an alternatives miracle (South Carolina isn't much better). Over the years, I've also written on abuses at public pension funds and have stuck my neck out plenty of times, most recently on how the media is covering up the Caisse's ABCP scandal.

Importantly, while 60 Minutes plugs Michael Lewis' new book and goes after ratings by claiming the U.S. stock market is rigged, the real wolves of Wall Street are thriving, raping large public pension funds on fees. Wall Street has license to steal and plenty of large and powerful private equity and hedge funds are feasting on the pension pig. And they will keep feasting and milking that cash cow dry until there's literally nothing left.

Now, I don't agree with Siedle's characterization of alternative investments as inherently risky. I've seen plenty of smart pension funds, including the great Ontario Teachers, get clobbered on their illiquid hedge fund investments, but that doesn't mean that these investments should be shunned for "less risky" liquid traditional investments.

What I do advocate for, however, is radical transparency at public pension funds, the type that would make the hair on Ray Dalio and Steve Schwarzman's neck stand up. I think laws should be passed forcing all public pension plans around the world to publicly disclose who they are investing with, how much and what are the terms of each of their investments in public and private markets. 

I also think public sector unions across the North America should contact Ted Siedle's firm, Benchmark Financial Services, and conduct a thorough and exhaustive forensic investigation of their public pension plan. I say North America because there are shenanigans going on everywhere, including here in Canada, but people remain absolutely clueless. Admittedly, the worst abuses are going on in the United States where the main problem with public pensions remains the lack of proper governance, feeding the Matt Taibbis of this world who love to sensationalize the looting of pension funds.

Below, North Carolina State Treasurer Janet Cowell on the challenges in maintaining public sector pensions (April, 2013). Maybe she should discuss how she is enriching her rich and powerful alternative investment donors, draining her state's pension fund of billions which taxpayers will have to cover in the future. What a scam, more evidence of the real pension Ponzi and Wall Street's license to steal.

Thursday, April 24, 2014

AIMCo Gains 12.5% Net in 2013

CNW reports, AIMCo Announces Strong Returns for Clients in 2013:
Alberta Investment Management Corporation (AIMCo) is pleased to report a 14.0 % net rate of return on behalf of its balanced fund clients, who represent $63.2 billion of assets under management, for the year ending December 31, 2013. AIMCo’s government and specialty fund clients, who represent $11.5 billion of assets under management, earned a net return of 4.0%. In aggregate, AIMCo earned a 12.5% net rate of return on assets under management of $74.7 billion, generating investment income in excess of $ 8.3 billion and active return of $589 million across all clients.

Public market investments , comprised of $ 25.5 billion in Money Market & Fixed Income and $32.0 billion in Public Equities, significantly outperformed their market benchmarks, as did Mortgages and Private Debt& Loan. Private Investments in Real Estate and Timberlands also contributed to the strong performance.  

States Leo de Bever, Chief Executive Officer, “Since AIMCo was created in 2008, we have been singularly focused on achieving superior return on risk on our clients’ combined assets of $75 billion. Size gives us the economies of scale and access to investment expertise that allows us to extract above market returns on the best available terms .” Since 2008 , the organization has delivered on its mandate, earning a five year annualized net return of 8.8% and approximately $3 billion in value added.

Detailed performance information will be available in AIMCo’s Annual Report to be release d in June 2014. 
In my last comment, I wrote about CAAT gaining 13.9% net, praising them for their excellent results. As I was writing that comment, I received an email notice on AIMCo, which posted the same impressive net returns in their balanced fund where the bulk of the assets reside.

Importantly, these returns are net of all fees, which is the way all pension funds should report their returns. I'm also glad AIMCo changed its reporting date to a calendar year instead of a fiscal year. I hope PSPIB and CPPIB do the same for comparison purposes but that is up to government bureaucrats in Ottawa.

What drove AIMCo's  strong 2013 results? The same thing that drove most of the returns at other pension funds, U.S. and global equities. Ben Dummett of the WSJ reports,
Alberta Fund Giant Benefits from Buoyant Equity Markets:
Alberta Investment Management Corp. said Wednesday it posted a 12.5% return last year, benefiting from improving equity markets as other big Canadian pension funds have done.

The double-digit gain beat the Alberta-based pension fund's benchmark return of about 11.5% and comes after Ontario Teachers' Pension Plan generated a 10.9% return last year and Caisse de Depot et Placement du Quebec posted a 13.1% gain.

Like these funds, AIMCo, which oversees 74.7 billion Canadian dollars ($67.7 billion) on behalf Alberta's provincial public sector employees, attributed its performance in part to its public equity holdings.

"We had an overweight to equities and that paid off quite handsomely," Leo de Bever, AIMCo's chief executive, told The Wall Street Journal in a phone interview.

Global stock indexes surged last year on expectations of improving global economic conditions. The U.S. broad-based S&P 500 stock index gained 30% in 2013, while the Stoxx Europe 600 rose 17% and Japan's Nikkei Stock Average benchmark gained 57%.

Looking ahead, Mr. de Bever suggests equities may not perform as well this year, but he remains more bullish on stocks compared with bonds.

"Over the next five years…I'd rather be in stocks than bonds because bond yields are either going to stay low" or if they rise that will hurt capital gains, the pension fund executive said.

In the fixed-income sector, AIMCo favored corporate bonds, and short duration debt, allowing these investments to outperform their benchmarks last year. The pension fund's real estate, and timberland investments in Australia also generated solid returns.

But repeating that performance is becoming more difficult because the "the pricing (for these assets) is getting very high," Mr. de Bever said.
Indeed, Gary Lamphier of the Edmonton Journal reports, AIMCo manager expects returns to moderate for 2014:
Alberta’s giant pension fund manager posted double-digit returns for 2013, marking the best performance in its six-year history.

Edmonton-based Alberta Investment Management Corp. (AIMCo), which oversees $74.7 billion of assets, recorded a net return of 12.5 per cent last year. In dollar terms, that equates to more than $8.3 billion.

The gains included a net return of 14 per cent on the balanced funds AIMCo manages for various public-sector pension and endowment fund clients, including the $17.3-billion Alberta Heritage Savings Trust Fund.

Balanced funds, which hold a mix of stocks, bonds and other securities, comprised more than $63 billion, or nearly 85 per cent of AIMCo’s total assets at the end of 2013.

AIMCo’s government and specialty funds, which largely hold conservative, low-return money market securities, posted a net return of four per cent last year.

The sparkling 2013 performance boosted AIMCo’s five-year annualized net rate of return — which dates back to the global financial crisis of 2008 — to a more-than-respectable 8.8 per cent.

Leo de Bever, the veteran 65-year-old pension fund manager who has served as AIMCo’s first and only CEO since the firm was spun off as a Crown corporation in 2008, says AIMCo’s nifty 2013 gains were driven largely by the sizzling performance of U.S. and global equities.

The S & P 500 Index, the main U.S. stock market benchmark, rose nearly 30 per cent last year, its best performance since 1997. Japan’s Nikkei 225 Index soared by well over 50 per cent and the MSCI World Index jumped more than 22 per cent.

“Last year if you stayed away from bonds and were overweight equities, that obviously worked out well,” says de Bever.

“Global equities did the best, followed by U.S. equities and then Canadian equities. So any of our peers that were heavily into Canadian equities wouldn’t have done quite as well as those who had global exposure.”

The S & P/TSX Composite Index, Canada’s main equity benchmark, posted a relatively modest gain of 9.5 per cent last year, trailing all of the major U.S. indexes by a wide margin. Canada’s resource-heavy index was weighed down by the poor performance of energy and mining stocks.

The roles have reversed thus far in 2014, however, as energy stocks have surged. Toronto’s lead index is up about 6.7 per cent through Wednesday’s close. That’s well above the 1.4-per-cent uptick in the S & P 500 Index, the top-performing U.S. equity index.

“After a year like last year people were obviously saying, ‘What are the parts of the market that are really overvalued, and what are the areas that got hurt?’ ” de Bever notes. “Well, what got hurt last year were resources stocks. That was both a China story and a developing world growth story,” as both slowed.

“This year we’ve had some political turbulence (notably in Ukraine) which is probably causing some of that money to flow back into energy, since there’s a feeling that energy security in Europe is now going to be what it is,” (i.e., less certain.)

So what kind of year does de Bever anticipate for equity investors in 2014?

“My guess is that when we get to the end of the year, the net return will be much more modest than what we saw last year, but that doesn’t mean it’s going to be negative,” he says.

“The overall top-line growth of the economy is not bad. It’s not great, but what’s happening is that the profitability of a lot of companies is still strong because they are implementing new ways of doing things, and using new technologies to save costs. So as long as (economic growth) is up, stock markets may hang in there.”

Indeed, while the generally accepted view is that economic growth since the 2008-09 recession has been softer than in past cycles, de Bever says he is beginning to doubt that conventional view.

“I think people probably underestimate the strength of the economy right now,” he argues. “The measurement system we use for GDP (Gross Domestic Product) is very good for industrial economies that make stuff, but it’s not so good for measuring ideas and services,” he notes.

“My sense is that growth is understated, and inflation is probably overstated. Sometimes we’re too morose about our growth prospects. I think the economy is probably doing better than people think.”
I agree with Leo de Bever, growth is understated (see Brian Romanchuk's latest comment, Commercial & Industrial Loans Holding Steady) and inflation is overstated. I also think stocks will continue to outperform bonds but going forward, deflation remains my single biggest concern, so bonds aren't dead by any stretch of the imagination (see Hoisington's latest economic commentary to understand why long bond yields have further room to decline). 

The only thing that irks me with all these Canadian pension funds reporting their results is that they don't release their annual report at the same time as they make their results public. The Caisse did post its annual report on its website, but the English version isn't available yet. HOOPP's full 2013 annual report is available here.  I am going to do a full comparison of all these large Canadian pension funds in the near future, looking at their annual reports in detail, comparing everything, including compensation and culture.

As far as my outlook 2014, I remain overweight U.S. stocks, the U.S. dollar, short Canada and the loonie, and still like high beta sectors, including biotech, and think the latest selloff presented another excellent buying opportunity, especially for NASDAQ shares.

By the way, did anyone notice how Apple's Tim Cook stuck it to short sellers by announcing a stock split and share buyback? Apple shares are rallying 8% today. He must have taken Carl Icahn's advice. The analysts covering Apple on Wall Street are frigging clueless. Most of the large Canadian pension funds, especially Ontario Teachers, loaded up on Apple shares during the last quarter, following the lead of other top funds.

Below, Canada’s Alberta Investment Management Corporation is opening an office in London – the first outside of Canada. Chief executive Leo De Bever talks to the FT’s Anne-Sylvaine Chassany about the company’s plans for Europe. Great discussion, well worth listening to.