CalPERS PE Fees Announcement Viewed as a Positive Step Towards Transparency

Sheridan Porter Blog

After announcing it will disclose private equity performance fees, CalPERS (California Public Employee Retirement System) has revealed that its carried interest payments since 1998 will total “in the billions”. As the largest state pension fund in the U.S., CalPERS is no stranger to scrutiny and criticism of its private equity dealings. Despite this disclosure being a step in the direction of greater transparency, it can nonetheless expect some controversy. Two years ago when South Carolina State Retirement System instituted a fee transparency initiative under treasurer Curtis Loftis, there was initial outrage at the fee totals. Similarly, the move by CalPERS will likely lead public officials to ask whether the performance of private equity relative to other asset classes has warranted such a high payout.
However, sentiment analysis of discussion conducted over social media revealed that the announcement by CalPERS was received positively. Using a supervised social media sentiment classification model, FEV Analytics measured the polarity of the sentiment of tweets regarding CalPERS before and after the release of the LA Times article. The sentiment model uses a financial dictionary of words, and then measures each word’s polarity score (how positive, negative, or neutral a word is) to determine the sentiment of tweets regarding CalPERS over a period of time. We aggregated the ‘opinion’ words from tweets about CalPERS over one week, subset them by sentiment, and then plotted their frequency on the graph below.

The graph shows a clear jump in positive tweets about CalPERS after the LA Times article, despite the article quoting the anticipated total as “ginormous”. There is a growing understanding of the private equity industry and its landscape of fees by public officials and pensioners alike. That growing understanding is fueling the call for more discipline from the asset owners on separating out manager skill from manager luck. After all, why pay a 20% performance fee if the majority of the ‘performance’ was actually luck.
The difficulty lies in quantifying manager performance – it has to be on a standardized basis, objective, reliably accurate, and efficient. Performance also has to be benchmarked to something – a peer universe or a public index – that meets the standard of a benchmark. To date, these factors have presented an obstacle too great for even the larger asset owners to manage. As a result, most asset owners select and monitor managers based on IRR performance (known to be a flawed system) and interview.
Asset owners can now access a new analytics tool that sorts and measures asset manager performance empirically and transparently on a standardized basis. FEV’s manager selection tools offer the most accurate and efficient way to quantify manager performance, separating out with great specificity the source of value creation. FEV technology calculates how much of an asset’s value is attributable to:

  1. operational change;
  2. deal negotiation and marketing skill;
  3. the timing of investment; and
  4. leverage.

All of these value sources can in some way be attributable to manager skill, but by splitting them out, asset owners can weight value drivers according to their own priorities. The tool is independent of the flawed IRR method and as such offers the industry a consistent way to surface and measure talented managers that may otherwise be overlooked.
CalPERS is expected to release the total figure for private equity performance fees this fall. It will be interesting to see if the appreciation for increased disclosure and transparency will remain as strong, or whether the focus will immediately shift to how the fund plans to measure and reward manager skill.
For more information on FEV private equity valuation and analytical tools, please send an email to warren@fevanalytics.com