Playing politics

The political risk faced by the private equity industry came into clear view this week when the governor-elect of New Jersey, Republican Chris Christie, asked the state to freeze alternative investments.

It is unclear exactly what views Christie holds about alterative investments as the incoming governor did not return calls for comment. In a letter to outgoing governor Jon Corzine made public in November, Christie outlined 14 emergency measures to prevent the “budget hole we are in from deepening”.

The 11th point on the list asks the state government to “freeze the retention of all new outside professionals, manager selections, and new contracts for managing alternative investments with respect to New Jersey's pension funds”.

A source told PEI the measure is “temporary in nature. The [Christie] transition team wants to review all the asset classes, which could be infrastructure, private equity, commodities, hedge funds and real estate,” the source from the state's Treasury department said.

New Jersey's pension has been investing in the asset class since 2005, when the investment council approved a 13 percent allocation to private equity, hedge funds and real estate.

At the time, the council had 11 members. Seven voted to move into alternative investments, while two members voted against the plan. A further two members were absent from the vote. The first year, New Jersey voted to spend $1.75 billion on private equity and committed more than $300 million to Warburg Pincus, Oak Hill Partners and Quadrangle Group in its initial commitments.

But from the beginning, political forces tried to counter the pension's move into alternatives. Two labour unions sued New Jersey's Treasury department to prevent it from hiring outside investment managers to take on the alternatives mandate. The suit argued that the state lacked the authority to hire outside money managers.

Moving forward, New Jersey's pension, like other public pensions in the US, suffered a decline in the value of its assets during the financial meltdown. As was reported in this column several months ago, James Marketti, a member of the council representing the AFL-CIO labour union, questioned whether it was possible for the pension to unwind its alternative investments.

During his campaign for governor of New Jersey, which he won in October, Christie attacked outgoing governor Jon Corzine for his ties to Wall Street. Corzine is a former chief executive officer of Goldman Sachs.

A vital question is how does Christie view private equity investments, especially in light of the ongoing and wide-ranging investigation into pay-to-play activities involving several public pensions in the US and private equity firms?

New Jersey has not been caught up in the pay-to-play debacle and for good reason – the pension early on established rules governing campaign contributions from investment firms or their representatives to members of the investment council. In hindsight, this eradicating of political taint from the investment process in New Jersey was a prescient move.

Still, for a self-proclaimed reformer like Christie, some of the corruption that has been surrounding the alternatives industry over the past months could become political fodder as he tries to score political points with his new constituents.

A cheap and easy victory could involve rooting out “risky” alternative investments in an effort to stabilise the sadly underfunded pension. Doesn't really matter if these investments really are as risky as portrayed – the perception would be easy to sell.

New Jersey has already cut back on alternatives. Its plan for this year has been to spend between $500 million and $750 million on private equity investments, between zero and $500 million on real estate and no investments in hedge funds. The pension has mostly been looking for opportunities to invest in secondaries and debt-oriented strategies.

As well as slowing its investment pace, the pension has been a leader in negotiating with GPs to cut fund sizes. It also joined its New York and Connecticut peers in meetings with the US' Federal Deposit Insurance Corporation to talk about rules governing private equity ownership of banks and was an early investor in the government's Public-Private Investment Programme.

Christie has time to work his way through all the areas he wants to review to find ways to close the budget gap in New Jersey. There is still hope that the alternatives programme will be left alone to work the way it should work – over time.