According to David Soares, a retired prosecutor and one of 732,000 pension-drawing former employees of the state of California, something is very rotten in his state’s pension system.
The California Public Employees’ Retirement System (CalPERS), which manages the benefits for more than 1.6 million state employees, retirees, and their families, is the nation’s largest public pension fund, with nearly half a trillion dollars of assets under its management. Soares and other retirees’ pensions depend on the investments CalPERS makes with that money, and he’s worried by the fact that increasingly, the fund has been investing those dollars in private equity firms.
As he noted with concern, “There’s just been this explosion of paying fees to private equity.”
Private equity is notorious for fighting minimum wage laws, closing hospitals, and stripping media companies to their bare bones. But even discounting their rapacious behavior, private equity firms often don’t deliver on their most basic promise, despite demanding high fees: producing market-beating returns for the entities that entrust private equity firms with billions of dollars in capital. Investors in private equity would often do just as well, and take on less risk, if they invested with publicly listed stocks instead.
Even if private equity firms score high returns, the fees — which are generally far higher than the fees charged by more traditional stock brokerages — will eat away at the profits going to the fund’s beneficiaries.
“The expenses are very high, and it’s hard for the citizenry to evaluate whether there’s a good return for those high expenses,” said Chester Spatt, professor of finance at Carnegie Mellon University.
CalPERS does not rank among the best performing funds over a one-year, five-year, or ten-year time frame, and its total assets are equal to only 71 percent of its financial obligations to its retirees. Despite underwhelming returns, CalPERS is doubling down on its current strategy: Its 2021–22 budget plan includes scaling up its dubious private equity investments by billions of dollars.
And as it deepens its involvement with private equity, CalPERS is also working to silence dissenting voices. In the run-up to elections to CalPERS’ governing board last month, several CalPERS board members came out in strong opposition to the last remaining private equity critic on the board, who was defeated in a landslide after several unions representing CalPERS beneficiaries spent hundreds of thousands of dollars opposing her candidacy.
In a world increasingly dominated by corporate profiteering, CalPERS’s growing reliance on private equity is the most glaring example yet of how Wall Street firms are gaining control of people’s retirement savings and fast-tracking the corporatization of the public sector, with little or no benefit to those who dedicate their careers to public service.
As a CalPERS beneficiary after thirty-two years spent working for the state, Soares is hoping that the system reconsiders its approach before it’s too late. “It was easier to work hard knowing there was a pension at the end,” he said. “I want that money to be there.”
“It’s a Crapshoot”
CalPERS first began to make serious investments in private equity in the early 2000s. While only 6.3 percent of the system’s funds are currently invested in private equity, CalPERS’s gargantuan size means that amount is roughly equal to South Carolina’s entire pension fund. In recent years, CalPERS has been increasing its involvement with private equity, as have many funds nationwide. The fund is now planning to increase its private equity exposure to 8 percent of assets, or roughly another $6 billion.
The planned expansion was still in the works as of September 2021, even as the returns from CalPERS private equity portfolio have lagged behind both CalPERS’s own benchmarks and the returns from its investments in stocks.
One reason for the shortfall is high fees, which exceed the costs associated with other investment categories by tens of millions of dollars.
The fees that CalPERS pays to private equity firms run into the hundreds of millions of dollars per year, and have been increasing. In the 2019–20 fiscal year, CalPERS paid $272 million in management fees to private equity funds, and an additional $277 million in profit sharing for the cut of returns taken by private equity firms.
In the budget approved for 2021–22, CalPERS projected $340 million in private equity management fees, an increase of $67 million, or nearly 25 percent. The budget plan didn’t include any projection for profit sharing fees, but they’re likely to increase as well as CalPERS increases its overall investments in private equity.
“To overcome those kinds of fees, a fund would have to beat the stock market by a huge amount,” economist Eileen Appelbaum, codirector of the Center for Economic and Policy Research, told the Daily Poster.
Besides the high fees, another pitfall of private equity is that its value over time is harder to track accurately than dollars invested in stocks or other publicly traded investments. The value of stocks is set by the market based on demand and is publicly available, updated to the second.
Private equity’s stated value, on the other hand, relies on the numbers published by fund managers, whose judgements of what the funds are worth are not consistent across the industry or even completely accurate. As Spatt at Carnegie Mellon put it, “One person’s judgement is another person’s baloney.”
The nebulous value of private equity makes it easier for pension fund managers to claim higher expected returns than for investments in publicly listed stocks. By projecting returns as high as 7 percent — yields that are generally unrealistic — pension fund managers can reduce the amount by which their funds are forecasted to fall short of their obligations in upcoming years, whether or not those private equity returns eventually materialize.
The top-performing private equity firms generally do outperform the market in any given year, even after fees. But if there’s a way to consistently invest only with top-performing firms, CalPERS and other investors have yet to discover it.
“There used to be a very high probability that the second fund of a [private equity] general partner whose fund did really well the first time would do really well,” Appelbaum said. “But that is no longer the case. Now, it’s a crapshoot.”
“Loaded With Good Old Boys”
CalPERS’s day-to-day operations are run by a department of thousands of employees, but its long-term management is the responsibility of its governing board. Six of its voting members are elected by public employees, and the remaining three are appointed by legislative leaders in Sacramento.
As CalPERS’s managers have made plans to scale up investment in private equity, the board has done little to dissuade them, even after CalPERS’s deputy chief investment officer Ben Meng resigned in 2020 after it came to light that he oversaw the approval of a $1 billion investment with Blackstone while holding Blackstone stock.
Knowing that pension fund managers and board members hold the purse strings to billions of dollars, Wall Street executives have developed an extensive playbook for winning pension officials’ favor, offering their targets free travel and lavish amusements with the hope of being entrusted with their funds’ dollars further down the line. Sometimes, it’s taxpayers who end up footing the bill for these luxuries. In Pennsylvania, the public school employees’ pension fund had the costs of travel to an annual conference at a luxury hotel in Beverly Hills written into the contracts with a private equity firm it hired.
Last year, the Daily Poster submitted a public records request to CalPERS and CalSTRS, the pension fund for California’s public educators, for agendas from similar conferences that California pension fund officials may have attended. CalPERS never responded to the request, but a representative of CalSTRS said that it had not found any such records, but if they existed, “they would not be public documents as they contain confidential and sensitive fund level information relevant to the partners of each fund.”
J. J. Jelincic, a vocal critic of private equity investments who served as a CalPERS board member from 2011–19, said his fellow board members often were never especially diligent as overseers of a nearly half-trillion-dollar investment fund. “The board has delegated away a lot of its authority,” he told the Daily Poster. “When I was on the board, I could tell that half the time, half the board had not bothered to read the agenda.”
Jelincic lost his bid for reelection in 2019. He blamed pushback from fellow board members and major independent expenditures against his campaign for his defeat, but his campaign also faced stiff public opposition from female public officials based on the fact that in 2011, he was formally reprimanded for sexual harassment in the course of his work at CalPERS.
Since Jelincic’s defeat, the board has voted to further decrease its own ability to oversee investment strategies, even as the fund has continued to produce lax returns. Now, says Soares, the California retiree, “The CalPERS board acts like they’re just a rubber stamp for the staff.”
Last month, another private equity critic lost her seat on the board: Margaret Brown was defeated by a landslide in her bid for reelection, receiving only 38 percent of the vote.
Brown’s reelection bid was undermined by the CalPERS board’s president, vice president, and three additional board members, who issued a statement supporting her opponent. Major unions — which often support pension systems’ investments in private equity, thanks to the promises of high returns — also came out in opposition to Brown. Several unions, including the Service Employees International Union (SEIU), spent more than $500,000 attacking her candidacy in addition to donating more than $100,000 to her opponent.
Brown did not respond to requests for comment by email and phone. But Jelincic alleges that Brown’s criticisms of CalPERS private equity investments were a factor in the board’s opposition to her reelection. “The board is really loaded with good old boys. Having somebody who doesn’t fit that mold and asks questions is uncomfortable,” he said.
With the main private equity critics gone from the board, it seems doubtful that CalPERS will be dialing back its private equity investments any time soon. According to Appelbaum, the approach is unlikely to produce great returns for California retirees like Soares.
“I’m not saying that they’re not getting a lot back from their private equity investments,” said Appelbaum. “They’re just not getting more back than they would have gotten by investing in an index fund and not paying all those fees.”
In other words, she concluded, “They’re not getting any premium for the risk that they’re taking.”