Los Angeles City Employees’ Retirement System is wrestling with the same dilemma as many LPs as markets gradually recover from covid dislocation: how hard it is to measure quarter-lagged private equity returns using benchmarks tied to public markets, especially during times of massive volatility.
On the surface, the numbers do not look good. As of June 30, LACERS’s PE portfolio returned -9.57 percent, net of fees, against a 22.87 percent benchmark over three months, -6.43 percent year-to-date against a -2.02 percent benchmark and -4.18 percent over one year against a 9.71 percent benchmark. Longer-term returns were all positive.
But those PE returns are lagged a quarter, meaning they reflect the state of the portfolio as of March 31 – the height of the market chaos triggered by the pandemic. Meanwhile, the benchmarks reflect the public markets as of June 30 – after the massive rebound in the second quarter.
At the September 22 LACERS board meeting, Carolyn Smith of investment consultant NEPC said there was a “mismatch” between the $19.2 billion pension’s private equity returns and the public equity index used to measure it – and that many pensions are experiencing exactly the same problem.
“We definitely have clients that use a proxy for the public markets similar to what you do, and a lot of those clients are having similar conversations to the one we’re having today,” she said, according to a recording posted online.
This problem has come up before. Earlier this year, Massachusetts Pension Reserves Investment Management Board executive director and chief investment officer Michael Trotsky raised an alert on the $75 billion pension’s own “mismatch” as first-quarter valuations came in after the public market rebound.
“It’s an apples and oranges comparison, if you will,” Trotsky told MassPRIM’s investment committee in July, as Buyouts reported. MassPRIM is in the process of of re-evaluating its benchmarking process. Earlier this month, Trotsky told the MassPRIM board the next round of PE returns would reflect that strong Q2 public market rebound.
Notably, LACERS uses the same benchmark as MassPRIM, the Russell 3000 index plus three percentage points, and its private equity returns also appeared to underperform in Q2.
Smith pointed out that NEPC’s last presentation, which Buyouts covered, showed the opposite dynamic, with lagged private equity returns appearing to massively outperform its benchmark, which at the time reflected the massive Q1 public market downturn. Now, the tables were turned.
“The downdraft in the first quarter was huge, and the uptick in the second quarter was huge as well,” she said. “This is not normal. These are unusual times.”
Benchmark changes
LACERS’s -9.57 percent showing in PE was comparable to most other private equity programs during the worst parts of the coronavirus crisis, but its benchmark gives a different impression – leading some board members to call for a change.
“We are addressing that dilemma that we have with our program,” said CIO Rodney June. “The private equity plan isn’t performing terribly, but I think in the context of this quarterly report…I think the board’s not getting an appropriate or accurate reflection of really how well the private equity program is doing.”
June said that most other public plans use a public markets benchmark, but sometimes buttress it with a “policy benchmark,” which would “evaluate the private equity program in and of itself.”
“It would be something supplemental to what we have [now], with the public plus the premium,” he said. “We’ll explore that over the next several months.”
June said the pension’s private equity consultant, Aksia TorreyCove, was preparing a presentation on benchmarking for the board, after which staff and its consultants would have a “joint discussion” about how to move forward. Earlier in the meeting, he stressed that what was more important, beyond the benchmark, was maintaining access to top-tier private equity funds.
Action Item: read the September 22 NEPC presentation to the LACERS board here.
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