Wednesday, May 12, 2010

New Jersey's Pension Fund Shouts PEU's

Bloomberg reported:

New Jersey Governor Chris Christie nominated a former partner in the Carlyle Group, the world’s second-largest private-equity firm, and two other financial professionals to a panel overseeing the state’s $68 billion pension fund.

Robert E. Grady
worked in venture capital investing at Carlyle before becoming managing director of Denver-based Cheyenne Capital Fund LP in 2009. Grady, who works from Jackson Hole, Wyoming, served as budget adviser to Christie’s transition team.

The New Jersey council sets policy for the 12th largest public pension fund in the U.S. Since 2006, the committee has steered $9.9 billion into alternative investments, including $3 billion in hedge funds, according to the most recent monthly report.

I found this interesting in light of two recent high profile appointments of private equity underwriters (PEU's), Erskine Bowles as co-chair of Obama's Deficit Commission and Fred Malek as head of Virginia's Government Restructuring Commission.

Certainly, PEU expertise is suited to pension investing, but that also carries potential conflicts of interest. Consider the pension fund's 2009 annual report and its PEU language:

The Common Funds are obligated, under certain private equity, real estate and absolute return strategy alternative investment agreements to make additional capital contributions up to contractual levels over the investment period specified for each investment. As of June 30, 2009, the Common Funds had unfunded commitments totaling approximately $7.7 billion.

Private equity comprised $2,982,420,463 of the New Jersey pension's investments as of June 2009. Unfunded commitments bring the total much higher, as much as $10 billion.

The fund's $7.7 billion promise looks like a planned future commitment, but they can be a surprise. PEU's make capital calls. California's public pension fund received $2.8 billion in capital calls in fall 2008.

The fund includes private equity under alternative investments. The description of risks is:

The pension funds’ interests in alternative investments may contain elements of credit, currency and market risk. Such risks include, but are not limited to, limited liquidity, absence of regulatory oversight, dependence upon key individuals, speculative investments (both derivatives and non-marketable investments), and nondisclosure of portfolio composition.
None of those risks change under financial regulatory reform, where private equity has a virtual free pass.

Meanwhile pension funds double down to crank up investment returns. Higher risk means higher reward. Public pensions look like Wall Street before the crash as they crank up "alternative investments." The annual report provides this description:

Alternative investments (private equity, real estate, real asset, and absolute return strategy funds) – estimated fair value provided by the general partner and/or investment manager and reviewed by management. The inputs into the determination of fair value (particularly for private equity and real estate) require significant management judgment or estimation. Because by their very nature, alternative investments are not always readily marketable, their estimated value is subject to uncertainty and therefore may differ significantly from the value that would be used if a ready market for such investments existed. The development of fair value is further complicated by (1) the current lack of liquidity in the financial system and (2) the extreme levels of volatility in the market for public equity in general and for debt securities linked to these asset classes. For these reasons, the realized value received upon the sale of these investments in the open market might be different than the fair value reported in the accompanying financial statements.
Surely, pension fund fence swinging will accrue to the benefit of employees. Returns could eventually trickle down, but New Jersey public workers feel the pain in the interim. Moody's approved of recent changes made to the fund.

Moody's praised the "major pension reform" signed in March — which reduces benefits for future hires and requires current employees to contribute to health care costs — as a step toward repairing the imbalance in the state’s pension system, underfunded by $46 billion as of last June.
The shift to individuals funding health care and retirement continues. Oddly, this is aided by health reform, where employers shed the health benefit to workers and a tapped out Uncle Sam.

Expect Obama's Deficit Commission to continue the dump via the "economy of delayed implementation" and conflicted policy setters. The New Jersey pension story is a fractal in the Government-Corporate Monstrosity, Eisenhower's MIC on steroids. Even Carlyle Group Chairman Emeritus Frank Carlucci revealed the fractal's PEU code.

Update 9-17-10 Grady will chair the State Investment Council and consider a recommendation to allow 43% of public pension investments in alternative investments, hedge funds, private equity, etc.

Update 3-21-11:  Grady called for an allocation review in January, pointing to the pension's cash position.

Update 8-21-11:  Bob Grady encouraged Gov. Christie to run for President. Asbury Park Press reported, "In 2000, Grady left for another plum financial job: the Carlyle Group, one of the world’s largest private equity firms."  Carlyle managed $3.3 billion in assets in 2000, a fraction of today's $153 billion.

Update 4-17-14:  The Grady-Carlyle Group-Christie connection has a bit more sunlight on it, but there's much left in the dark.