Headline Risk vs. Capital Risk
October 4, 2010
It was major news when the AP reported South Carolina’s state pension would be the first in the nation to adopt a direct investment model for its PE program. Who knew Mark Sanford spent enough time off of the Appalachian Trail to get something like this in motion. As it turns out, it was probably the governor’s truancy that allowed the SC Retirement System Investment Commission the time to get it off the ground. Sanford’s 11th hour intervention, though, highlights exactly why something like this won’t work in the US.
The direct investment model undoubtedly makes sense for pensions. The Ontario Teachers’ Pension Plan in Canada, headed by Jim Leech, continually proves itself to be among the more sophisticated investors in the market and its recent hiring of Jane Rowe, who previously oversaw Roynat Capital, shows the pension is willing to pay market prices to build a capable team.
For those wondering how LPs and GPs can align interests, taking PE in house is probably the only absolute solution. It gives investors complete control and eliminates fees. The only problem – and it’s a big one -- is that politics have a knack for skunking otherwise solid ideas.
The key sticking point would be the mandate. Do the projected eight percent returns trump the social impact?
No incumbent legislator wants the next election to rest on whether or not the state pension took a dividend recap at the expense of a local business. And even if the mandate stays true to the returns, if the local politicians have a grasp of the “J Curve” affect, this effort is guaranteed to die in committee.
The other problem is compensation. South Carolina’s state budget has slashed almost $2 billion since the downturn, representing almost a quarter of the budget at its peak. When federal stimulus dries up, more cuts are likely, and a moratorium on new construction projects at state universities hints at where future trimming will occur. Moreover, the state's two public pensions have an unfunded liability of nearly $18 billion, prompting Sanford to concede via twitter that the pensions "are broke."
The editor in me knows that the salary of a market-compensated funds manager would make for a great headline amid all this – even if it ignores the savings and potential profits generated by adopting a direct investment model.
Even Harvard’s endowment has had trouble solving this riddle, so now it probably pays former head Jack Meyer more in fees as a third-party manager than it paid him when he was overseeing the entire endowment. And the performance has suffered to boot, underscoring that even private colleges are more fearful of headline risk than capital risk.
Somehow, in Canada, they've managed to sidestep the political issues of the direct investment model. In the US, even as Tarp is on pace to provide a return to taxpayers, it's proven to be a political hot potato whose ownership no politician or even party wants.
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