Ex CalPERS board member asks for report on credit line use

Former CalPERS board member Michael Flaherman raised the issue of fund-level leverage use by GPs for the second time at Monday’s meeting, after no action was taken following remarks he made in December 2015.

The California Public Employees’ Retirement System failed to follow up on a request asking to analyse the use of subscription lines of credit by its general partners, according to comments made during the $320 billion pension plan’s investment committee meeting on Monday.

Private equity fund managers’ use of credit lines has been on the rise in recent years, fuelled by low interest rates and access to cheap debt. These credit facilities, which can artificially boost investment performance by delaying capital calls, have also been drawing attention from limited partners concerned with the opaqueness surrounding them.

Most recently, former CalPERS board member Michael Flaherman provided public comment to the CalPERS board about fund-level leverage in private equity during the plan’s investment board meeting on Monday. He referred to a note written by Los Angeles-based Oaktree Capital Management’s co-chairman Howard Marks a few weeks ago on the benefits and drawbacks of credit line use, as reported by Private Equity International. Flaherman noted that he brought up the issue at the end of 2015.

“The reason I wanted to talk is that in December 2015 I gave public comment before the board about an issue, which is fund level leverage in private equity, said Flaherman, who is a scholar at the University of California Berkeley. “The reason why I bring it up today is that the chair [of the investment committee Henry Jones] instructed the staff at the time to bring back a report on the issue and to my awareness that never happened. There was never a report brought back.”

CalPERS, which has $26 billion of its assets in private equity, was not available to comment.

The Institutional Limited Partners Association is also gathering LP opinions on the use of fund-level credit facilities as part of a wider consultation with its members and confirmed LPs are seeking greater transparency regarding their use. ILPA plans to include recommendations in its guidelines, as reported by PEI.

“This is an increasingly common practice and raises significant concerns of systemic risk for your private equity portfolio,” said Flaherman, who served as a CalPERS board member between 1995 and 2003 as indicated on his LinkedIn profile.

He said this is a concern, especially considering the issue has been increasingly brought up in the industry.

Flaherman also noted that Marks wrote about how GPs use such credit lines to boost their own compensation, which largely depends on the performance of a fund’s portfolio.

“It is especially concerning when the chair instructs the staff to bring back a report about hidden risks in your portfolio and they do not do it; and then you have somebody like Howard Marks pointing out [that] the hidden risks serve to bump up people’s compensation,” he said to the board on Monday. “And so I hope that there might be some effort to address this, especially just recognising that this is a conflict of interest.”

CalPERS investment committee member JJ Jelincic responded that the Sacramento-based pension indeed received information about leverage, but could not confirm whether CalPERS had any discussion around its risks. “I know we have gotten information about the leverage,” he said. “I don’t know that we’ve had any discussion about the incremental risks and I’m wondering if we couldn’t ask staff to comment on that.” Investment committee chair Henry Jones said he will follow up with staff.

Flaherman suggested CalPERS that the pension invite Marks to give a presentation on credit lines, noting that Marks manages “a lot of CalPERS’ money”.

According to CalPERS’ website, the pension fund committed $200 million to the 2011-vintage Oaktree Opportunities Fund VIII-b, which was generating a 3.2 percent net internal rate of return for the pension as of 30 June.

Flaherman was not available to comment.