Lieutenant Island Views : Commentary About Finance, Politics and Baseball

The End of the Beginning or the Beginning of the End of Hedge Fund and Private Equity Economics? | March 30, 2009


Saturday’s Wall Street Journal has an interesting article (“Calpers Tells Hedge Funds To Fix Terms-Or Else”) which details the California Public Employees’ Pension Fund’s (“Calpers”) attitude toward hedge fund and private equity compensation. Calpers is the nation’s biggest public pension fund. It has seen its hedge fund and private equity portfolios decimated this year along with its myriad other equity oriented investments. This is necessitating a reallocation of their portfolio which will mean substantial cuts in funding for “alternative investments” like hedge funds and private equity. Calpers’ reallocation issues has done more to put the fear of God into heathen PE and hedge fund managers than would any overzealous preacher! Loss of Calpers money can put a dent into any fund’s asset base and be a harbinger of incremental losses as other funds follow Calpers’ lead. Reallocation also gives Calpers extraordinary “muscle” to demand favorable terms from those with whom it chooses to invest. As the article points out, some of the modifications in terms that it is looking to achieve include:

• Reduction in annual fees (now 2-3% on avg.) and carry from 20% to something significantly less
• Recoupment of fees paid in good years to cover subsequent bad performance
• Managed accounts solely for Calpers to reduce the impact of redemptions by other investors
• Greater disclosure of assets and potential limits to leverage

Implementation will come primarily with the deployment of new money rather than amendments of existing fund investments. While it will take some time to implement the changes desired, they will have a chilling effect on the compensation and operations of many hedge funds and PE shops. Because so many institutional fund investors follow Calpers example it is likely that some fund managers will opt for dissolution or be forced to that decision by an inability to raise adequate capital. If Calpers succeeds, the face of alternative investments will look very different in the coming years. It also won’t help the value of homes in the Hampton’s or large apartments on Park Avenue.

It is quite possible that the fund business will follow the example of Major League Baseball. Top performers like Paulson and Soros may still be able to demand their terms because of their stellar track records in the recent downturn. Others will see a dramatic change in life and pay because they did not measure up in the clutch. There won’t be many Johan Santanas or Albert Pujols in the fund world. To make matters worse, Calpers is signaling that they have no intention of spending as freely as the Steinbrenners!

http://online.wsj.com/article/SB123818466240759815.html

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2 Comments »

  1. This would not be the first time Calpers used its muscle to effect the financial landscape in ways that have political implications. Those who run Calpers may be faceless, but they’re not shy.

    Are you saying that you wouldn’t be jumping up and down with excitement if the Red Sox acquired Pujols or Santana?

    Comment by drtone — March 30, 2009 @ 7:05 pm

    • I agree with you about Calpers using its muscle. That said, they are flexing now even more than in the past. That is not to say I am either critical or suspect that they won’t be successful. I actually believe that they are doing the correct thing. When billions are being put at risk by pension funds, there should be a meaningful differentiation between the best and less good. This should include carry percentage as well recapture for bad performance. I also believe that all but small VC funds should pay ordinary income tax on their carry rather than capital gain taxes.

      Regarding Pujols or Santana, you may have missed my point. I am comparing them to John Paulson and George Soros. They are at the top of the heap in baseball. Like Soros and Paulson, they will continue to get their money because they perform so well. Guys who are good but not in the top 5% are likely to suffer from market adjustment

      Comment by bosox4 — March 30, 2009 @ 7:38 pm


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About author

Mr Thaler is currently the Managing Partner of Lieutenant Island Partners, an organization providing corporate finance advice and general consulting to corporations and not-for-profit organizations. Mr Thaler retired as Vice Chairman of Deutsche Bank Securities in early 2008. His background includes experience as an investment banker, senior manager, business builder, college professor, not for profit board chair and trustee. In his thirty plus years as an investment banker for Deutsche Bank and Lehman Brothers, he has been involved in numerous significant debt and equity financings, mergers & acquisitions, leverage buyouts, restructurings and cross border transactions. Of particular note, Mr Thaler has been one of the most active participants and strategic advisors to the homebuilding industry. In a period of significant turmoil and losses, he was one of the few active bankers to the industry who did not have either a loss or credit write down. He is currently advising several public builders on strategic matters and is an adjunct professor of finance at Morehouse College in Atlanta, Georgia. Though he lives in New York, he is a life long Red Sox fan! www.LieutenantIslandPartners.com

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