CalPERS Tackles PE Legislation
The California pension giant opposes proposed legislation on allocations to PE funds of sovereign wealth investors
By Kelly Holman March 24, 2008
Sovereign wealth funds have drawn much attention from many corners, including Congress. But, proposed legislation in California seeking to restrict pension fund allocations to sovereign wealth-backed private equity firms is taking center stage in the institutional investor community.
The Responsible Private Equity Investment Act of 2008 bill (AB 1967) was sponsored in mid-February by Democratic assemblyman Alberto Torrico and the Service Employees Union International, the labor organization that vehemently protested Washington-based Carlyle Group's acquisition of Manor Care last year. The act would prohibit the California Public Employees' Retirement System (CalPERS) and the California State Teachers' Retirement System (CalSTRS) from allocating capital to private equity firms that have sold stakes in their management companies to sovereign wealth funds, mainly those of countries not in compliance with international human rights treaties. Some sovereign funds are affiliated with countries "with human rights records that are among the worst in the world," the bill states.
The proposed legislation has left industry observers scratching their heads.
"It's unclear what the goal of this legislation is," says Bruce Ettelson, a partner in Kirkland & Ellis who heads its private funds group. "You're basically causing the private equity funds to choose between the sovereign wealth funds and California pension funds, in which case the private equity funds may choose the sovereign funds because they may have more money and less investment requirements," he says.
If passed, the new measure would require California pension managers to file public reports within 60 days of making a final investment decision.
Considering that CalPERS and CalSTRS manage $240 billion and $167 billion of assets, respectively, the proposed legislation isn't insignificant. Moreover, the nation's two largest pension funds are investors in a substantial number of private equity limited partnerships, but their assets are dwarfed by that of the foreign state-sponsored funds.
Sovereign wealth funds have amassed $3.05 trillion of assets and committed some $120 billion to $150 billion to private equity, according to London private equity data provider Preqin's new report on sovereign wealth investors.
"As large as California pension plans are, the collective amount of money that's both currently in sovereign funds and may be there in the near future may heavily outweigh that of the California pension plans," Ettelson says.
And, the gravitas deep-pocketed sovereign wealth funds from Asia and the Middle East bring to US financial institutions like Citigroup, which secured $7.5 billion from the Abu Dhabi Investment Authority in December, has become more apparent over the past year as the wave of bad credits engulfed Wall Street and the private equity industry alike.
"It seems important for our financial system, government and industry to maintain open arms for foreign investment," says R. Adam Smith, managing partner of New York private equity firm Circle Peak Capital.
"If it is a sovereign wealth fund that's legitimate without any ties to illegal activity, then why should CalPERS not be able to invest?", asks Alexander Leykikh, a principal at Atlantic-Pacific Capital, a Greenwich, Conn.-based fundraising organization.
Leykikh thinks Torrico's proposed bill would limit an important source of capital for the private investment industry. "To me it seems this sort of regulation would not work. If it's Middle Eastern wealth funds with money from sources that we feel are safe, that clears the most important hurdle," he says.
Sovereign wealth investments haven't undergone the same rigorous national security regulatory scrutiny that foreign company-sponsored M&A deals receive because the funds have taken minority stakes of less than 10% in their investments in US businesses. Thus, a review by the Committee on Foreign Investment in the United States (CFIUS) isn't required.
CalPERS' buyout and venture capital fund allocations are managed through its alternative investment management (AIM) program. The AIM program has generated $12.6 billion of profits for the pension manager since it was established 17 years ago. CalPERS, which posted a 14.1% return from AIM over the last decade, says $3 billion of investment gains would've been wiped out if it hadn't invested in private equity firms that had received sovereign wealth money. These investment groups, incidentally, manage more than $9 billion collectively for CalPERS' AIM program and account for 20% of its total assets.
A CalPERS spokesman declined to comment on the legislation, saying its board would make a decision based on its investment committee's recommendation that Sacramento, Calif.-based CalPERS oppose the bill.
On March 17, CalPERS' investment committee and a third party consultancy, Pension Consulting Alliance, addressed the proposed measure in an agenda report. The CalPERS staff believes that many top-performing investment funds are likely to sell minority interests to sovereign funds, meaning that if AB 1967 were enacted it "would further restrict the universe of funds in which the AIM program could invest" and make it more difficult for it to secure positions in top performing funds at acceptable terms.
"If CalPERS is prohibited from investing in private equity firms partially owned by an SWF, the investment performance of the AIM program will be materially adversely affected. CalPERS will not be able to obtain first-quartile returns in the future because it would cut off CalPERS' access to top-quartile funds," the pension fund's investment staff wrote. As a result, the expected returns from the AIM program would not justify future investments in private equity, CalPERS' investment committee wrote, because of the "greater risk associated with private equity."
CalPERS itself has also made its own direct, minority-stake investments in prominent buyout groups. In January, it took 9.9% of Menlo Park, Calif.-and New York-based technology-centric firm Silver Lake, seven years after making a similar $175 million investment in Carlyle.
It isn't the only organization that believes foreign state-sponsored funds will invest more capital in buyout groups and their funds. "Numerous organizations that we investigated are looking to step up their private equity programs, and of those that currently do not invest in private equity, a number were looking to increase their allocations," says Tim Friedman, head of publications and marketing at Preqin.
Friedman says that the proposed legislation might also spur private equity firms to view sovereign investment vehicles in a new light: "It's likely that the proposal of this bill might change the attitudes of certain private equity firms towards sovereign wealth funds, and might change their positions on who they will accept investment from, and the ways in which they will accept investment." However, he doesn't believe general partners will be keen "to lose such an established and valuable investor base in Californian public pension plans."
CalSTRS, also a Sacramento-based organization and an administrator of benefits for California's 813,000 public school educators and their families, has already opposed the Responsible Private Equity Investment Act of 2008. In a statement issued on March 6, Jack Ehnes, chief executive of CalSTRS, said the bill ignores the realities of the global financial market where sovereign wealth funds contribute capital as passive investors, referring to minority stake investments taken by sovereign vehicles like Abu Dhabi's Mubadala Development's $1.3 billion investment in Carlyle.
Private equity was the best performing asset class for the pension manager last year, generating a 33% return, according to CalSTRS. CalSTRS has said the bill's passage would increase costs as well as reduce its investment revenues by $1.5 billion to $5.3 billion over the next five years.
Charlene Davidson, a senior managing director and investment banker at Costa Mesa, Calif.'s RSM EquiCo Capital Markets, thinks the legislation is troubling and a knee-jerk reaction to the rising popularity of the foreign state-sponsored investment funds. "It appears to be more of a reactionary maneuver than a research-based action." Davidson points out that New Jersey Governor Jon Corzine has welcomed deep-pocketed sovereign wealth investors with open arms. "The State of New Jersey is hosting meetings with sovereign wealth funds to bring them in as qualified investors," she says.
SEIU president Andy Stern raised the issue of human rights when he took up the issue of sovereign wealth funds investing in private equity funds in November 2007 at the Asia Society of Southern California. In a speech at the Asia Society, he said deals like Abu Dhabi's $1.3 billion investment in Carlyle "should not serve to underwrite human rights violations and anti-worker business practices."
"It's really difficult to use the international market to solve human rights issues," says a CalSTRS spokeswoman, adding, "We have a long history of responsible investing and respect for human rights."
Oliver Gottschalg, an assistant professor of strategy and business policy at Paris' HEC School of Management who recently issued a study analyzing the private equity industry, says sovereign funds run by countries in the Middle East have long made direct investments in strategic businesses with little, if any, ill effect. "Kuwait has been a big investor in Daimler for decades, which, to my knowledge, hasn't hurt anyone. It's surprising that this now comes up all of a sudden as the sovereign wealth funds have become more active and seen as something threatening."
(c) 2008 Investment Dealers' Digest and SourceMedia, Inc. All Rights Reserved.
Find out more information about people mentioned in this article from our People Database:
Charlene Davidson
Bruce Ettelson
Alexander Leykikh
