CalPERS employs a pool of eight advisors who work on different aspects of its alternative investment programme, but the one area with which the pension needs no help is deal flow. When you're one of the largest backers of private equity funds in the world, PPMs come flying through the door by the hundreds. Although advisors sometimes come to him with a new investment opportunity, says Leon Shahinian, the new senior investment officer of the California pension's alternative investment management group, “typically, it's already in our shop. Everything comes here first”.
Indeed, many things happen at CalPERS first, and Shahinian's job is to continue taking advantage of this dominant position within the private equity industry while managing the crushing work flow associated with that opportunity. Shahinian also must cope with a less pleasant aspect of leading a CalPERS investment team, one that his predecessor Rick Hayes has called “living in a fishbowl”.
The California Public Employees' Retirement System is a magnet for civicminded scrutiny and political posturing
As a major public – and highly politicised – institution, the California Public Employees' Retirement System is a magnet for civic-minded scrutiny and political posturing. As recently as September, the pension was sued to disclose details of the management fees paid to private equity fund managers – a sort of “welcome to the job” gift for Shahinian, who only weeks earlier had been named the new head of alternatives.
With the management fee issue, as well as in all other aspects of his brief tenure at the top of CalPERS' private equity programme, Shahinian has displayed an unflappable, methodical approach that brings with it the expectation of teamwork both among CalPERS' investment staff, with its advisors and with its 112 general partner groups.
It won't be hard for Shahinian to pick up where Hayes left off because the two have worked together since 1998. Hayes hired Shahinian three months after being hired himself as the number-two to then-private equity head Barry Gonder.
At the time, Shahinian was working at the nearby offices of Foundation Health Systems as a fixed-income portfolio manager. A former colleague alerted him to an open position in the CalPERS alternative investment group because she knew he always wanted to be an “investment banker” Shahinian recalls, smiling.
Hayes and Shahinian were disappointed to find that CalPERS did not enjoy a stellar reputation as an LP, despite its status as the largest public pension in the US. Hopeful fund managers complained that they couldn't figure out the relationship between the pension and its gatekeepers. GPs said they didn't know who to approach first with an investment opportunity.
Other GPs had shied away from CalPERS in part because they feared a militant approach to terms negotiations. This reputation, deserved or not, stemmed in part from a legendary altercation between former CalPERS chief investment officer Sheryl Pressler and Henry Kravis, an incident that got the pension banned from the 1996 KKR fund.
Perhaps as a result of this “mixed reputation”, as Shahinian puts it, he and Hayes began with what they considered to be a sub-optimal collection of private equity funds to which the pension had committed capital.
The pension hired consulting firm McKinsey & Company to study the best ideas for running a large private equity programme. Hayes and Shahinian spent two years implementing McKinsey's recommendations. In 2001, Gonder left the pension to join Grove Street Advisors, an alternative investment consultancy that is among CalPERS' advisors. Hayes was named senior investment officer of the alternative investment management team.
The CalPERS alternatives team was slowly built up to include spots for today's eight investment professionals and three administrative staff members. Hayes, leveraging his pension's weight, also turbo-charged the formalisation of the Institutional Limited Partners Association, a forum where – in many cases for the first time – major LPs could exchange information and ideas about investing in funds.
Under Hayes, CalPERS also raised eyebrows when it bought stakes in the management companies of several private equity firms, including The Carlyle Group and Texas Pacific Group, as well as newer firms like New Mountain Capital and Audax Group. Hayes reasoned that since a commitment from CalPERS often had a powerful galvanising effect on a firm's business, the pension should be able to share in the growth of the franchise. Most recently, Hayes and team announced a $200 million commitment to a fund managed by distressed specialist WL Ross in exchange for a 20 percent stake in the fund's management company.
Hayes left the pension in June to build a fund of funds business for Oak Hill Capital Management, a private investment conglomerate affiliated with the Robert Bass family of Texas. (Hayes will remain based in the Sacramento area).
During a recent interview at the terraced, gardened CalPERS headquarters at 400 P Street, Shahinian said he is very pleased with the platform that he and Hayes have built, and that he doesn't see any “major changes” to the private equity programme. “It's going to be business as usual, with some nuances”, he says.
Shahinian says he is especially happy with the quality of people that work for him and for the clearly delineated, consensus-oriented approach to investing that has been built within his group. This, he says, has been the most important factor leading to the “reputation enhancement” that CalPERS has enjoyed.
Each Monday, the CalPERS private equity team meets to discuss the many investment opportunities that find their ways to 400 P Street. At the meetings, the junior and senior investment officers seek unanimous agreements on which partnerships to move forward with. If just one or two team members object to a particular fund, the opportunity is in many cases dropped altogether, or sometimes the commitment is significantly reduced.
Shahinian calls his team's approach to investing a “true partnership”, adding, “If you look at our organisational chart, it looks like it's a multilayered structure, but in practice it's really not”.
Once the private equity team agrees on a partnership, it is sent to a consulting firm for “heavy lifting”. Currently, CalPERS' alternative investment advisory firms include Blomquist & Company; Hamilton Lane; KPMG; Pacific Corporate Group; Probitas Partners; Sextant Search Partners; State Street Bank Private Edge Group and Thomas Weisel Partners.
STATE OF THE BEHEMOTH
Prior to his departure, one of Hayes' last projects with Shahinian was to prepare for the annual alternative investment performance review, presented before the full CalPERS board each October. The review is important in that it “really drills down into the details of what is driving our performance”, says Shahinian, who had always joined Hayes in previous performance reviews.
According to Shahinian, the current CalPERS private equity portfolio has never appeared stronger. In 2004 year to date, for the first time, the private equity partnerships to which CalPERS has committed capital returned more money than they drew down, totaling more than $2 billion in distributions through August 31. Overall, the CalPERS private equity portfolio has generated more than $6 billion in returns since its inception in 1990. This is balanced against the $13 billion that has been contributed since that time. The pension currently has about $20.6 billion in funded and unfunded commitments to private equity.
CalPERS and its private equity advisors calculate a rate of return since the 1990 inception at 10 percent for all funded and unfunded investments (fully realised investments over the same period chalk up at 19.1 percent). Shahinian says this compares favourably against a number of benchmarks, but notes that the pension did not benefit from the 1990s venture boom because it was “late to the party” with respect to that strategy. Overall, on a dollar-weighted basis, the CalPERS private equity programme is rather young, as the pension enormously expanded its allocation to private equity in the late 1990s. In its buyout fund portfolio, which commands the lion's share of the programme's allocation, the average age of a fund investment is just 3.9 years old.
The brightest spots in the CalPERS portfolio are at its margins. For example, the secondary funds to which Shahinian's group has committed just $767 million have generated a net IRR of 19.2 percent as of March 31. Distressed funds have returned 17.3 percent. Private equity investments in Europe, which currently total just $1 billion, have vastly outperformed US investments – 23.6 percent vs. 9.76 percent, respectively.
Shahinian would like to see the portfolio become more geographically diversified and “nuanced”. He is keen to further expand into the European market through large and, especially, middle-sized, funds. Through March 31, the CalPERS private equity portfolio saw a 34 percent jump in European investments. Shahinian is also optimistic about China and India, and his team is looking into Mexico as an area of potential growth.
On US buyout funds, Shahinian remains committed but is “neutral” about the performance outlook of this broad sector. “Investment style matters, and manager selection is critical, but you've got to take a global view”, he says.
The method by which CalPERS will create a more balanced portfolio is currently under review. With a target allocation to private equity of seven percent on an overall $165 billion pension fund, CalPERS will continue committing to new partnerships at a brisk clip. But Shahinian says his team has recently given “a lot of thought” to whether the pension should rebalance its portfolio through the sale of some of its current holdings on the secondary market.
Turning an old phrase on its ear, you can't take Sacramento out of the boy, and you also can't take the boy out of Sacramento – Shahinian has lived in and around California's state capitol for most of his life. Although born in San Francisco, the Shahinians moved to a suburb of Sacramento when Leon was six years old, and he hasn't really left since. He attended college at California State University, Sacramento, and got his first financial job as a credit analyst at Sacramento Commercial Bank. His next gig was at the Sacramento office of Foundation Health.
Not surprisingly, Shahinian loves his hometown, but he would like to travel more. Under his predecessor, Shahinian would typically hold down the fort while Hayes would visit GPs off-site. But CalPERS being a state entity, travel for Shahinian is more of a hassle than private sector professionals can imagine. Every trip must be painstakingly documented and justified to an oversight body. Says a former CalPERS employee: “Most people have no idea how difficult it is to work at a public pension. If some agency decides that there's no more money because of a state budget issue, even though we're investing a billion dollars plus a year, and we need to monitor our investments, they'll say: “You cannot travel”.”
Working for CalPERS involves issues more explosive than travel. Shahinian must cope with state rules that do not permit investment staff members to be paid market wages. The pension has also been a magnet for open-records lawsuits aimed at forcing disclosure of information on the private equity portfolio. After a series of legal scrimmages, CalPERS in 2002 agreed to provide fund-level IRR information on its private equity portfolio – a landmark move that signaled a new standard of disclosure within the privacy-minded private equity community.
Shahinian's team now faces a new and equally thorny issue – management fee disclosure. CalPERS has been sued by the California First Amendment Coalition – a freedom-of-speech advocacy group – to disclose the fees the pension pays to alternative investment fund managers. The suit puts CalPERS in an awkward position because management fees vary from partnership to partnership and, sometimes, within the same partnership from LP to LP. Shahinian argues that making his group's fee agreements public knowledge would harm CalPERS at the negotiating table. “All a GP would have to do is look up our Web site and say, “Ah hah – we can see that you've never paid less than X”.”
The lawsuit also leaves open the possibility that information requesters would have access to tens of thousands of documents related to capital calls, quarterly and intermittent reports and partnership agreements. The litigation could pan out in a number of ways. Shahinian and CalPERS may be able to offer a compromise policy of disclosing top-line, aggregate fees, and in doing so, steal a page from their IRR-disclosure playbook. Most private equity market participants would now argue that fund-level disclosure is fine, but portfolio-company disclosure would be toxic. Similarly, a publicly disclosed schedule that simply read, “Firm X – $20 million; Firm Y – $25 million”, would be deemed far less injurious to the disclosing parties than would a document laying out specific terms.
Neither the affected GPs nor the California First Amendment Coalition have agreed to any policy and the lawsuit is still pending. CalPERS recently had the court date pushed back to December 2.
Stating unequivocally that he'd rather be spending his time worrying about investment performance, Shahinian says that he and his team have, as a result of the most recent lawsuit, exhaustively reviewed the pension's options.
adds, is “taking a hard look” at laws passed in a handful of states that make private equity information offlimits to open-records requests.
A former colleague describes Leon as devoid of an ego and “a very hard worker who doesn't get excited or emotional about things”.
Well, most things. Like many suburban American kids, Shahinian played soccer. Unlike most Americans, he remains passionate about the sport. Ever since being mentored by a Brazilian soccer coach who had once played against sporting legend Pele, Shahinian has been transfixed by what the rest of the world calls football.
“Growing up, there was only one public station that carried soccer games”, remembers Shahinian. “It was a show called “Soccer Made in Germany”. Now – unfortunately for my wife – I get two cable channels, Gol TV and Fox Sports World”.
On the occasions that Shahinian shows up tired-eyed to work, his colleagues know he's been up late watching matches in foreign lands – events sadly not optimally scheduled for California fans.
Shahinian's devotion to soccer takes a different form than his approach to private equity – he focuses on the individual players, not the teams. The other difference is that almost any private equity player in the world will make the trip to Sacramento to see Shahinian. For the record – if Wayne Rooney, David Beckham or Pele have the time, Shahinian would be happy to free up his schedule for a visit.