LA County’s PE program costs were $37 mln higher than reported

Los Angeles County Employees Retirement Association’s private equity program last year cost 71 percent more than what the $52.5 billion retirement association previously reported, an external consultant report obtained by Buyouts shows.

The Aug. 9 report, prepared for LACERA by Pavilion Alternatives Group, found PE management fees, partnership expenses and “other fees and expenses” totaled almost $90 million during the 2016 fiscal year. LACERA’s annual report, which covers the same period, reported $52.6 million of private equity fees and expenses.

In addition to fees and expenses, Pavilion also found that LACERA’s general partners collected $102.9 million of carried interest during FY 2016.

How and why are unclear

It’s unclear how or why the program’s costs were $37 million higher than what LACERA reported in supplemental materials for its annual financial report. (See chart.) Pavilion’s presentation did not disclose the extent to which discrepancies could be attributed to errors on the part of LACERA or its fund managers, or if there were other causes.

Both are possibilities. A 2015 audit found LACERA had “no process for validating private equity fees,” Buyouts reported last year. The same audit showed LACERA could not verify valuations and fund audits provided by the external managers of the PE program’s underlying funds.

In a statement to Buyouts, LACERA would not say exactly how it calculated PE costs before it adopted the Institutional Limited Partners Association’s standard template, which was formally introduced in 2016.

LACERA noted that it’s been difficult to apportion fees, expenses and investments using capital-call and distribution statements. LACERA’s books are managed by its custodial bank, State Street Bank and Trust.

Meanwhile, in its report, Pavilion wrote that GPs were underreporting some fees and expenses “due to reporting complexity.”

Pavilion checked the costs the fund managers reported for “reasonableness, including tests for overall accuracy and completeness,” according to the report. Almost half the submissions required follow-ups to address inconsistent or incorrect information, in addition to items that were “flagged for further review.”

Pavilion Managing Director Raelan Lambert presented the report at LACERA’s Aug. 9 investment board meeting. She did not respond to requests for comment.

LACERA is treating the review of its $4.9 billion PE program as “an on-going effort” and anticipates that calculating total fees and expenses will grow easier as more firms adopt the ILPA reporting template, according to emailed responses to questions from Buyouts.

“The Private Equity program has been successful (the best performing major investment strategy over the past 10 years). We will continue to negotiate in the best interest of our members. Private Equity and other asset categories are continuously reviewed by the Board,” LACERA staff wrote.

3500 hours

LACERA tapped Pavilion to review its PE program’s various fees and expenses last year. Like many public pensions, including larger institutions like California Public Employees’ Retirement System and California State Teachers’ Retirement System, Los Angeles County’s retirement association faced questions about its ability to track the fees and expenses charged by its fund managers.

Most of LACERA’s private equity program’s external managers — GPs representing 242 of its 253 active funds — participated in Pavilion’s review.

Some 38 percent of those managers provided information through the ILPA template. Pavilion calculated the fees and expenses for 60 percent of LACERA’s managers using financial statements and supplemental material the GPs provided.

The latter effort was particularly time-consuming, according to the report. LACERA spent more than 3,500 man-hours standardizing the reporting data submitted by LACERA’s fund managers, “which was more than initially planned,” LACERA Principal Investment Officer Christopher Wagner wrote in a memo.

LACERA said in an email to Buyouts that the Pavillion report does not affect the reported value or performance of its PE program, both of which are already presented net of all fees and expenses.

“While the incremental disclosures [i.e., the Pavilion report] enhance transparency, they do not impact the fair value of the underlying assets. It is important to note that LACERA’s CAFR net of fee valuation has not changed,” according to the statement.

LACERA’s PE program was valued at $4.9 billion as of June 30. It was netting a 16 percent internal rate of return since inception as of Dec. 31, beating its benchmark by a full percentage point.

Action Item: For more information on LACERA, visit www.lacera.com

People watch the solar eclipse on the lawn of Griffith Observatory in Los Angeles on Aug. 21, 2017. Photo courtesy Reuters/Mario Anzuoni