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Covid crisis highlights ‘mismatch’ in MassPRIM PE benchmarking

The $75bn fund's benchmarking structure makes it hard to measure private equity performance during periods of market volatility.

On the surface, Massachusetts Pension Reserves Investment Management Board‘s first-quarter PE performance does not look bad at all compared to the chaos in the public markets.

But according to executive director and chief investment officer Michael Trotsky, it is still primarily responsible for the pension underperforming its benchmark by about 150 basis points for fiscal year 2020.

But, Trotsky said, this does not point out an issue with the $75 billion pension’s PE portfolio, but instead one with the benchmark itself.

“The relative underperformance was due almost entirely to a private equity benchmarking anomaly that occurred in the June quarter,” Trotsky said at an investment committee meeting Tuesday. “These anomalies happen from time to time and are exaggerated in periods of extreme volatility.”

MassPRIM’s PE portfolio had a negative 8.3 percent return for the first quarter and a 4.4 percent return for the fiscal year.

During that quarter, public markets went down about 20 percent, Trotsky said. During the second quarter, they went up almost the same amount.

MassPRIM’s private equity benchmark is the seven year annual average return of the Russell 3000 index plus 300 basis points. Trotksy said the last seven years have been “very strong” for the Russell 3000. That creates problems when it gets compared to more short-term private equity returns during the recent downturn.

“Our performance report as currently structured compares PRIM’s one-year private equity performance to the seven-year average return of the benchmark,” Trotsky said. “That is a mismatch of time periods. It’s an apples and oranges comparison, if you will.”

Were the PE returns averaged over the last seven years as well and then compared to that benchmark, it would outperform them 18.8 percent to 14.3 percent, Trotsky said.

Moreover, the pension’s private equity returns are reported on a quarter lag, meaning there is no data yet available for the second quarter.

“The benchmark includes the strong rebound in June, but the PRIM PE values do not reflect that rebound,” Trotsky said. “And that’s another serious mismatch, because again there was a 40 percent swing in the markets between the March and June quarters.”

“Due to the long-term nature of private equity, comparing private equity to a public equity benchmark over short periods of time can be misleading, especially during periods of extreme volatility,” Trotsky said.

In February, MassPRIM’s board approved issuing a request for proposals for a benchmarking consultant to help re-evaluate the fund’s process. The request will be issued in early September with a recommendation later this year, MassPRIM told Buyouts via email.

Investment committee member C. LaRoy Brantley, himself a principal at investment consultant Meketa Investment Group, asked about the fund’s practice of benchmarking its one-year PE returns to its own performance. Trotsky said staff did this precisely because of the benchmarking issue he had mentioned.

“We don’t really have a one-year benchmark for it,” Trotsky said. “Nor should we.”

“That was my beef before…[that] we’ll never beat it but we’ll also never underperform it,” Brantley said. “If you’re putting in the June performance for the benchmark and we have no performance to report for the asset class, that’s always going to be a problem unless the benchmark itself is underperforming by a huge amount.”

Brantley offered a solution to this problem.

“When there’s no performance for the asset class for the benchmark to remain consistent…I zero out that benchmark’s component for the private markets because there’s nothing to show there, and that ends up being fair at both ends,” Brantley said. “It doesn’t show us outperforming the markets on the way down and it doesn’t show us underperforming when the markets have a great period. So I would put forth that as an option for you because I think it’s unfair to have performance in the benchmark when there is no performance in the portfolio.”

In an email, MassPRIM told Buyouts the performance would never be “100 percent apples-to-apples unless there is a passive option in the market to measure the opportunity cost.”

Later, private equity head Michael Bailey told the board he expected a strong rebound for the portfolio in the second quarter, in alignment with the public markets rally.

“We did a lot of work to X-ray the portfolio since the pandemic began to affect the companies, and only a small portion of the companies are at risk of impairment in our opinion as a result of the pandemic,” Bailey said. “We are seeing some early positive results that make us optimistic that when we meet again in November we’ll be able to report a better Q3 number…more on track to the kinds of quarterly numbers you’re used to seeing out of the private equity portfolio.”

Brantley did not respond to a LinkedIn message requesting comment. A representative for Meketa declined to comment.

Action Item: check out MassPRIM’s performance as of June 30 here.