After Scandal, New Mexico Ushers In New Era

“Following a deeply disappointing chapter in New Mexico history”—as Gov. Susana Martinez recently put it—reforms put in place were aimed not only at making sure such a scandal never happened again. They were also designed to ensure that the governance, employees, policies, advisors and investment decisions focused on achieving strong returns with an appropriate level of risk.

When a six-year period of alleged corruption came to light in 2009, returns had dropped to the bottom quartile for the one, three and five-year periods among public investors managing at least $1 billion in assets, according the Wilshire Associates’s Trust Universe Comparison Service. Worse, the council’s investment performance in the 10-year trailing period ending in 2009 was dead last.   

Now, nearly three years into the ongoing overhaul, the results have been transformative for the council, whose $17 billion in assets make it the second-largest sovereign wealth fund in the United States after Alaska’s. As of December 2012, Wilshire Associates reported that the one-year investment performance of 14.5 percent was in the top 15 percent of public investors with at least $1 billion in assets. Returns were 9.1 percent for the trailing three-year period, placing it in the top half.

As for private equity, one of the asset areas at the center of the scandal, the seeds of a turnaround also seem to have been planted. The asset class returned 14.9 percent in the 12 months ending December, outperforming its benchmark, the 80/20 Cambridge Associates PE Index, by 1.5 percentage points. However, private equity has still underperformed the Cambridge index for the three, five and 10-year trailing periods, with the 10-year under-performance amounting to a tear-inducing 450 basis points per year.

Reforms

One of the first things the council did in the wake of the scandal was to fire its private equity advisor, Aldus Equity Partners. Saul Meyer, Aldus Equity Partners’s founder who pleaded guilty to securities fraud in New York, acknowledged in his plea agreement that he recommended investments “pushed on me by politically-connected individuals” who stood to benefit financially.

The council also pursued civil law suits to recover money that was lost from the scandal, and has so far negotiated settlements of $26 million from some of the parties allegedly involved. Spokesman Charles Wollmann said he anticipates the three alleged primary actors in the scandal— Gary Bland, the former state investment officer, Anthony Correra, a well-connected advisor to former Gov. Bill Richardson, and Marc Correra, Anthony’s son, who acted as a placement agent and earned millions of dollars for helping obtain investment commitments from the council— will appear in civil trials 2014. 

Meantime, under the leadership of Steve Moise, who was hired as state investment officer in April 2010, the council has embarked on a bottom-up review of policies and procedures to investigate what had gone wrong and—just as important—figure out how to create a top-quality investment organization. In a recent interview with Buyouts, Moise said he was guided by a single mission: “To see that something like this scandal never reoccurs in New Mexico.” 

The need for change was especially crucial for the underperforming investment program. The council first hired Vince Smith, a former chief investment officer at the Kansas Public Employees’ Retirement System, in September 2010 to be deputy state investment officer, a role that functions as a CIO. 

The council ended up replacing all but one of its outside investment advisors, as well as 15 external investment managers, mostly for underperformance. Given the legacy of the placement-agent scandal, the council banned outside investment managers from paying placement fees on investments made by the council.

“The most important thing we do is prudently manage our investments…and it became apparent to us that [our portfolio] was not of institutional quality,” said Moise. The council didn’t even have an investment committee, an audit committee, or a governance committee, he said, “so we set up those committees.”

Another big step was to reduce the council’s target return rate from 8.5 percent to 7.5 percent, which meant investment decisions would not have to be as aggressive as in the past. One benefit of this was to reduce the council’s reliance on equity assets, which in 2009 constituted approximately 80 percent of the overall portfolio.

“Equities have not been a very good performer since the 2000 market-top,” said Smith, who joined Moise for his interview with Buyouts. “Consequently, neither had our portfolio.” As a result, “our reforms are primarily about diversifying the portfolio and seeking sources of returns outside of equities.”

Private Equity

The council plans to maintain its 10 percent target allocation to private equity for the foreseeable future, which translates into committing up to $450 million a year to the asset class through 2021.

Overall, the council manages roughly $1.6 billion in private equity capital. It has another $730 million in unfunded commitments. After LP Capital arrived in 2011 as New Mexico’s private equity advisor, the firm recommended several changes to the portfolio, including more diversification by strategy, industry, geography and vintage year.  

Toward that end, the council intends to reduce its reliance on North American private equity funds from roughly 80 percent of the portfolio to between 60 percent and 70 percent. Meantime, private equity investments in Asia and emerging markets are slated to rise from roughly 5 percent of the portfolio to between 10 and 20 percent. Smith said the council favors “investments in places that have above-average GDP growth because GDP growth is the raw material of investment returns.” 

Meantime, the council has also focused on reducing the number of general partner relationships from 83 to fewer than 50, including between 25 and 30 ‘core relationships.’ To do that, the council plans to reduce the number of new commitments from around 13 per year, as was the average between 2004 and 2007, to between six and eight per year. At the same time, its average commitment size has grown from roughly $25 million, the average between 2004 and 2007, to between $50 and $100 million.

Smith said that the changes to the private equity portfolio wouldn’t be drastic. So far, he said, “we haven’t reduced the number of managers much at all. And we haven’t done a secondary sale, either.”

“We’ll still be fairly well diversified,” added Smith. “But that means we’ll probably have half the number of funds that we have now, which is a little over 100. And that [reduction] will mostly take place through attrition.”