peHUB Wire: Friday, May 8, 2009

In the wake of New York’s kickback scandal, public pension funds have been bending over backwards to declare their independence from placement agents. Some new policies have been reasonable (see CalPERS), while others have been reactionary (see New York City and New York State). Overall, however, they’ve been diversionary.

Simply put, placement agents are well down on the list of things that are wrong with public pension systems, vis-à-vis their investments in private equity. Here are five more destructive issues – none of which are being publicly addressed by elected officials or their mouthpieces.

1. Politicians

There is no greater source of corruption in public pension systems than the elected/appointed officials charged with being those systems’ fiduciary. Not just Treasurers and Comptrollers, but also Trustees and other such officeholders. I’m not saying they’re all rotten (not even close), but far more of these people have taken kickbacks than have private equity portfolio managers.

Some of the kickbacks are Hank Morris-esque, while the majority come in the form of campaign donations or other favors (hello out-of-state Hevesi donors). All of them, though, result in downward pressure on PE portfolio managers to pay special attention to certain investment prospects.

“When I took over [State Pension System X],” one former manager told me, “I was informed that I was responsible for 80% of our private equity investments. When I asked about the other 20%, I was told not to worry about it.” I’ve heard that same story repeated over and over, sometimes with the percentages flipped.

2. Staff Turnover/Compensation

It’s a big deal when an insitution like Harvard or Yale loses a senior private equity manager. When it happens at a public pension fund, everyone just shrugs their shoulders. “Of course they left,” people say, “The money’s better elsewhere, and your boss doesn’t change every four years.”

Investment staff turnover at public pensions results in a shortening of institutional memory, a lengthening of decision-making and a general instability that can give general partners pause. But few public pension seem willing or able to do much about it. There’s obviously no way to alter the electoral system, but a solid case could be made for raising salaries and prioritizing the filling of open positions. You’ve got to spend money to make money, and investment offices are the one part of state and municipal government that is expressly designed to make money.

It’s great that NYC Comptroller William Thompson said on CNBC yesterday that he wants to “beef up” his internal investment staff, but why has he let his “managing director of private markets” job stay unfilled for so long? And why are there still no job postings for those other (phantom?) positions, more than a week since the placement agent ban was put into effect? On the upside, I was able to find out that the City does have a “director of private markets.” Her name is Liz Caldas. For some reason, Thompson’s press office still doesn’t know who she is.

3. Emphasis on Local Investment

Want to drive down investment returns? Allocate a portion of your portfolio to be invested locally, whether or not there are adequate investment opportunities. It can sometimes work for a system like CalPERS — thanks to the in-state presence of Silicon Valley — but it’s usually a PR coup that becomes a balance sheet nightmare (remember the Ohio Bureau of Workers Comp carveout? Ouch!).

And this isn’t just anecdotal. Josh Lerner of Harvard Business School once published a paper that found a “negative proximity effect” when it came to limited partner commitments to general partners. If you expect your private equity portfolio managers to double as economic development pros, then you’re likely to be disappointed.

4. Over-Reliance on Outside Consultants

A lot of public pension systems either outsource all of their private equity investment matters, or a healthy portion of them.

This is understandable (refer back to #2), but also can pose even worse problems than can placement agents. After all, wasn’t Aldus Equity a discretionary consultant for New York Common Retirement System? You know, the same Aldus that is now the subject of criminal charges?

I’m not arguing for a ban on consultants — any more than I’d argue for one on placement agents — but public pension systems should demand much more transaparency and accountability from their hired gatekeepers. Not just internally, but externally. Don’t just tell me that Consultant A recommended a particular fund. Tell us why, and how the relationship originally began and progressed. If it turns out that the consultant lied about the timeline or rationale, fire them.

5. Greater Overall Transparency

Six years ago, the University of Texas Investment Management Co. (UTIMCO) decided to begin publishing fund-specific performance data for its private equity managers. CalPERS and CalSTRS followed suit (after fighting it in court). At the time, certain private equity wags suggested that these institutions would be given the cold shoulder by secrecy-obsessed general partners, thus reducing the pension systems’ ability to access top funds.

It is true that certain GPs bailed (venture firm Sequoia Capital, most notably), but the effect has been largely negligible. In that spirit, let’s get as much info out there as possible. Tell us how fund investments were sourced, why the investment is being made, how it fits into an overall allocation strategy, etc. We get some of this from a few pension systems, but most keep their mouths shut. And even the few that release full returns data are typically tardy updating their numbers.

If you keep everything in the dark, don’t be surprised when something goes bump.

Top Three

Great Hill Partners has agreed to sell Custom House Ltd. to Western Union Co. for $370 million in cash. The deal is expected to close next quarter. Custom House is a Canadian provider of payment solutions for small and mid-sized enterprises, and is being advised on the deal by Financial Technology Partners.

VKernal Corp., a Portsmouth, N.H.-based provider of virtual appliances for managing virtual server environments, has raised $7.06 million in second-round funding, according to a regulatory filing. It had previously raised $4.6 million from Hummer Winblad Venture Partners and Polaris Venture Partners. peHUB has learned that Longworth Venture Partners led the round. Also worth noting that Doug McNary, former CEO of Onaro, has joined the vKernal board of directors.

Macquarie Group is bidding for AIG’s asset management unit, according to Bloomberg. The unit, AIG! Investments, has around $100 million under management, and the auction is expected to generate upwards of $500 million.

VC Deals

Sadra Medical, a Campbell, Calif.-based developer of therapies to treat aortic valve disease, has raised $30 million in Series C funding. Accuitive Medical Ventures led the round, and was joined by return backers Boston Scientific, Finistere, Firstmark Capital, Oakwood, ONSET Ventures, and SV Life Sciences.

Enphase Energy Inc., a Petaluma, Calif.-based developer of micro-inverter systems for the solar industry, has raised $22.57 million in new VC funding, according to a regulatory filing. No investor info was disclosed, but the company’s website identifies three investors: Appplied Ventures, Rockport Capital Partners and Third Point Management.

TRA, developer of a household-level research system to report ROI accountability for advertising spend, has raised $13.5 million in Series B funding. Arbitron Inc. led the round, and was joined by return backers Kodiak Venture Partners and WPP.

Tokai Pharmaceuticals Inc., a Cambridge, Mass.-based maker of drugs that focus on focus on endocrine treatment, has secured $10 million of a $22 million venture round, according to a regulatory filing. No investor names are disclosed, although the company’s board includes a pair of partners with Novartis Ventures. The company previously raised funding from Queensland Investment Corp.

I Love Rewards, a Toronto-based provider of employee reward, sales incentive and service award programs, has raised C$6.9 million in Series B funding. GrandBanks Capital led the round, and was joined by JLA Ventures and Laurence Capital. Ryan Moore of GrandBanks will join the company’s board of directors.

DocuSign Inc., a Seattle-based provider of online document delivery and signature solutions, has secured $5 million of a $15 million venture capital round, according to a regulatory filing. The company had previously raised around $28 million, from firms like WestRiver Capital, Frazier Technology Ventures, Ignition Partners and Sigma Partners.

Kalido Inc., a Burlington, Mass.-based provider of data warehousing and management software, has secured $3.08 million of a $5.15 million venture round, according to a regulatory filing. It had previously raised over $40 million through four rounds, from firms like Atlas Venture, Balderton Capital and Matrix Partners.

SupplyFrame Inc., a Pasadena, Calif.-based vertical search engine for electronic components, has secured $1.5 million of a $4 million funding round, according to a regulatory filing. The company previously raised around $12 million over two rounds, from firms like U.S. Venture Partners, Clearstone Venture Partners and Arcturus Capital.

Aspen Medtech Inc., a Bellevue, Wash.-based medical device incubator, has ceased operations, according to VentureWire. The company had raised around $1 million in 2007 from Prospect Venture Partners and Three Arch Partners. Its website is still active.

Buyout Deals

Gordon Brothers and Hilco Consumer Capital have completed their acquisitions of Polaroid, out of bankruptcy.

Greenwoods Capital and Scorpion Capital have acquired the assets of Champion Broadband California, operator of broadband services in the Arcadia and Monrovia communities. RBC Daniels advised CBC on the deal.

PNC Equity Partners has acquired APEX Analytix Inc., a Greensboro, N.C.-based provider of recovery audit services. Sellers include VC firms Noro-Moseley Partners and Wakefield Group, while leveraged financing was provided by Union Bank, TriState Capital Bank and Babson Capital Management.

Firms & Funds

3i Group (LSE: III) has launched a $1.1 billion rights issue. Read more…

Human Resources

Richard Shafer has joined the The Ohio Public Employees Retirement System (OPERS) as deputy director of investments for external management. He previously was director of investments for the New Hampshire Retirement System and, before that, was chief investment officer of the Alaska Permanent Fund.

Lauren McKibben has joined PNC Equity Partners as director of business development. She previously was an account manager with Provident Analysis Corp.

Margaret Ren has stepped down as chairwoman of Merrill Lynch’s China investment banking group. No word yet on her future plans. Ren is the daughter-in-law of former Chinese premier Zhao Ziyang.