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CalPERS: GP negotiations an ‘uphill battle’

The pension’s day-long private equity workshop revealed many frustrations with transparency and the complexity of the asset class, despite its role as a top performer in the investment portfolio.

In a day-long private equity workshop on Monday, staff at the California Public Employees Retirement System (CalPERS) disclosed that, despite being one of the largest private equity investors in the world, the pension does not feel it has much bargaining power when it comes to negotiating terms with GPs.

The $300 billion pension is enduring “an uphill battle” with GPs, who are successfully employing a “divide and conquer approach to negotiations” with investors, CalPERS counsel Marte Castanos said during the workshop presented to CalPERS’ investment committee. The board has endured criticisms over its private equity investing abilities following a previous board meeting in which staff incorrectly answered a question about the structure of fee-offsets.

“We’re on an island,” Castanos said. “We know there are other negotiations going on in parallel but we’re unaware of them, and the GPs like to keep it that way.”

Castanos and CalPERS outside counsel Paul McCoy of Morgan, Lewis & Bockius described several roadblocks CalPERS faces during limited partnership agreement (LPA) negotiations, including the difficulty in changing pro-GP terms agreed to in previous agreements, the threat of being shut out of a fund due to too many comments on an LPA, and antitrust laws prohibiting LPs as a group from yielding greater market power.

Further limiting CalPERS’ clout at the negotiating table is GPs being aware of the terms CalPERS privately agreed with other managers, primarily due to the overlaps in outside legal counsel from GP to GP, Castanos noted.

“It would be naïve of us to think that that database of what CalPERS has agreed to doesn’t exist. It’s made clear that they understand what you’ve agreed to before,” said McCoy.

CalPERS staff and outside experts spent much of the workshop discussing whether the challenges of private equity, including the high costs and complexity, were worth the benefits that the asset class brings to the portfolio. Although it is CalPERS’ most expensive asset class, private equity yields the highest net returns, returning 8.9 percent in fiscal year 2015.

Staff are working toward increased disclosure and transparency in order to combat those challenges, and briefly discussed a recent US Securities and Exchange Commission case against The Blackstone Group for its use of accelerated monitoring fees, describing it as one example of progress. The case helped “open up a dialogue between LPs and GPs on a granular level that did not exist beforehand,” a CalPERS board member said.

Despite the concerns aired at the meeting, CalPERS chief investment officer Ted Eliopoulos closed the workshop with high hopes for increasing transparency, noting that the pension’s plan to shrink its number GP of partnerships from 422 to only 100 by 2020 should lead to reduced risk and complexity and enhanced monitoring and governance.