Frankly, I was quite impressed with the board of CalPERS recently reaching out to me, as much as they voiced to be impressed with me and my writings. Writings which, I could tell, this board member had intensely studied, despite or because not all favorable to their progress and process.
A wonderful gesture considering the generally stubborn nature of the grand institutions of our society, in this case, the largest U.S. pension fund with some $347 billion in assets-under-management (AUM). Unique also because it demonstrates the fund is not looking for answers solely from the conventional well of asset-management wisdom. The well they have been exploring for so long and is frankly running dry, as I personally gathered from the late Joseph Dear. Most importantly, the members of the fund, the pension holders, deserve fund managers who keep an open mind on how to optimize the returns from their hard-earned contributions.
I will not publicly reveal the exact conversations I have had with CalPERS. Conversations, I told them, that must be held after CalPERS completes the appointment of their new chief investment officer, in charge by January 2019.
Yesterday’s article in Pensions & Investments describes CalPERS’ new private-equity four-pillar distribution plan. A reference which instantaneously induced a Pavlovian response, bringing me back to the ridiculous four-pillar plan the NVCA once published to attempt to improve the performance of the subprime and dysfunctional VC sector, that left limited partners clamoring for returns.
“The idea is to divide the portfolio into four pillars: investing in commingled funds, the current model; a fund-of-funds type portfolio, investing in emerging managers; and two direct investment strategies that would be run by the separate limited partnerships.”
After the dust of my initial response settled, it dawned on me how not all board members or investment committee members could possibly have read my missive on how to reinvent Asset Management. A missive that, for one, clearly highlights how returns must be correlated to the risk of the underlying asset, not to the type of distribution bucket you managed to conjure up.
Direct or indirect?
The second observation that struck me is how the distribution strategy alludes to direct investment vehicles while, given the setup of the proposed limited partnership corporations, neither of them is supported by CalPERS employees manning those companies, and thus, in essence, is an indirect investment strategy with merely a single voting shareholder.
Not a bad strategy on the surface, unless CalPERS hires CEOs in the two limited partnerships from the same pool they deployed their past indirect investments with. In that case, the mere attempt to cut out management fees to protect the downside is not what propels the pursuit of upside, as I have explained in previous articles ad nauseam. Or in the words of Einstein depicted by the image above, do not expect a fish to climb a tree, despite how much or how little you feed it.
The innovation strategy described in the article refers to late-stage investing at the nexus of life sciences, healthcare, and technology, which, in essence, alludes to an allocation to late-stage venture capital. As luck will have it, late-stage investing in venture capital, after a fledgling company has managed to cross the chasm, now indeed carries a private-equity risk-profile with fierce deal competition and easy money aplenty.
The risk profiles of venture capital and private equity are diametrically opposite, as I have explained before, with the fuzzy explanation in the article not instilling confidence CalPERS communicates or understands the fundamentals of risk very well. Which I believe to be the core competence of asset managers, or is it?
The real opportunity for the innovation strategy CalPERS must seek to deploy is the one 99.4% of venture investors are incompatible with seeking and finding, as they are hopelessly deadlocked in the collusion of make-believe and in blatant violation of the most basic socioeconomic values for humanity. An allocation to world-changing ideas, like in Tesla (no VC supported), with the potential to create outlier returns, can only come from a fishing net contrary to the overwhelming uniformity of what Silicon Valley deploys today.
Put differently, any investment in innovation that changes the norm and produces outlier returns must consist of cradle-to-IPO runway support. Not become a me-too allocation and distribution of more good money after bad in late-stage or secondary opportunities.
The second limited partnership described in the article focuses on what CalPERS calls “durable business models, capable of attractive cash yields over time with the opportunity to grow revenues by taking advantage of longer-term investments and a platform approach to building a portfolio.” Here, of course, comes the placebo effect of ESG to mind. Read my articles.
The method of producing returns in this partnership must be geared not towards what humanity wants but to what humanity needs. We do not need more sugar-water on this planet for humans to consume. We need an investment strategy closely aligned to our evolutionary strengthening that builds a robust and healthy membership base upon which a pension fund depends.
What plagues pension funds today is that they all produce more or less the same returns, the amplitude of asynchronous ups and downs resembling the equivalent of irritating and uninspiring white noise. I do not have in-depth insight into the performance of CalPERS’ commingled funds, the fund-of-funds type portfolio, and the investment in emerging managers to argue their specific strategy, viability and foresight here.
In general, however, asset management constructs have become rebels without a cause, detached from the risk profiles of the underlying assets, and instead stuck in artificial constructs of aging and stale asset allocation buckets to, at best, protect downside risk. Unable to produce the returns to prevent CalPERS from eventually having to tap into the state’s coffers and potentially raising taxes on all Californians.
The real innovation we can bring to CalPERS is to establish a new normalization of evolutionary truth, by which the role of asset management is elevated to the fractal of human expansion, tapping by design, not by a musical-chair game of risk escapism, into the nose, the torso, and the long-tail of ever-expanding human ingenuity and capacity.
I suggest we have another talk.