Draconian “cradle-to-grave” provisions in private equity and real estate funds, permitting investment managers to extend fund lifetimes and charge investors fees virtually forever, are commonplace—yet almost universally overlooked by even so-called sophisticated public pensions. Rhode Island Treasurer Seth Magaziner, championing “financial literacy” at high schools across the state, seemingly has no problem with the state pension paying Governor Gina Raimondo’s former firm indefinitely for private equity underperformance. How many other private equity and real estate investments in the nation’s public pension portfolios, such as CalPERS, have similarly harsh cradle-to-grave provisions?
Earlier this month I wrote that it seemed unlikely the Rhode Island state pension would ever be able to exit the dismally performing $5 million investment sold to the pension in 2006, by former General Treasurer, current Governor Gina Raimondo before she entered politics. Rhode Island Treasurer Seth Magaziner’s office failed to answer my repeated questions regarding whether the agreements the state had entered into permitted additional extensions of the life of the fund and, if so, how many extensions were permitted and under what circumstances? I concluded that unless 80% of the investors in the fund (including friends and family of Raimondo)—someday agree to end it, Rhode Islanders shouldn’t be surprised if the final accounting of this investment was delayed until Raimondo safely exited Rhode Island politics.
The Raimondo investment is unique in that there is no other investment in the state’s portfolio that was sold to it by the current Governor, former Treasurer.
However, Rhode Island’s state pension is chocked full of many other private equity and real estate funds which may have similar cradle-to-grave provisions. We can’t know for sure because Treasurer Magaziner will not permit public scrutiny of the relevant fund agreements. State secrets, it seems.
Worse still, severely underfunded public pensions across the nation are gambling heavily on private equity funds seemingly unaware their assets may be locked-in for 50 years or more. Last week, California Public Employees’ Retirement System, the nation’s largest public pension fund voted to move forward with a plan that could add another $20 billion in private equity investment into the portfolio– supposedly as a means to improve investment returns and overcome increasing pension liabilities.
Mark Renz, Chief Investment Officer at Socius, a multi-family office in Fort Lauderdale, offers prospective clients “transparency reviews” focusing on fees, expenses, and risks. Renz has seen private equity and real estate funds which have cradle-to-grave provisions permitting the investments to continue for up to 50 years. Worse still, most of these funds have no absolute limitations—they can go on forever.
“Most people don’t really know what they own or signed up for. When I tell them they may be stuck for a lifetime—generally when performance is suffering—nobody’s happy. The risks related to cradle-to-grave provisions are almost never discussed with investors.”
David Darby, Managing Partner at DG Wealth Partners in Palm Beach Gardens, also advocates transparency reviews for prospective clients and shares Renz’s concerns. “Obviously, it is in the General Partner’s financial interest to extend the life of the fund until performance improves and in the meantime the GP profits by continuing to collect fees. Heads, the GP wins; tails, the LPs lose—whether performance improves or not.”
“The problem is most acute,” says Darby, “in fund of funds which are popular among retail investors. Fund of funds, which invest in dozens of underlying funds, almost guarantee the retail investor will be lock-in for far longer than he anticipated.”
Despite long claiming to be the gold standard, the very fact that CalPERS, a massively underfunded state pension, is taking such a wild private equity gamble should be cause for alarm, in my opinion. Gamblers who double-down usually crash and burn. More worrisome, other public pensions gambling in private equity and real estate are even less savvy.