Friday, December 16, 2011

Hard Reality of Private Equity

At the NYCERS investment board meeting on September 16, 2011, the NYCERS private equity (PE) consultant, Pacific Corporate Group (PCG), notified the trustees that one of its PE investments, Allegra Capital Partners IV, had exited during the first quarter of 2011. See the Wikipedia quote below:

A private equity fund's ultimate goal is to sell or exit its investments in portfolio companies for a return, known as internal rate of return (IRR) in excess of the price paid. These exit scenarios historically have been an IPO of the portfolio company or a sale of the company to a strategic acquirer through a merger or acquisition (M&A), also known as a trade sale. Increasingly, more common has been a sale of the portfolio company to another private equity firm, also known as a secondary sale. In prior years, another exit strategy has been a preferred dividend by the portfolio company to the private equity fund to repay the capital investment, sometimes financed with additional debt.

I have previously commented on the problems of PE investments for public pension funds.

PCG stated that this is the second NYCERS PE investment to exit since the PE program was started in 1999. I suspect that the first PE investment to exit was the Emerald Infr. Dev. Fund. It was a disaster with a total loss of capital equal to $1M and fees for two years (2009 & 2010) equal to $754,338.

PCG did not give the trustees any specifics on the close out of the 12 year old Allegra partnership. But from the PE investment recap you can extract some of the bad news. NYCERS invested $24M in this partnership and received back $11.7M. That is a 51% loss of capital and obviously, a negative IRR.

To rub salt in the wound, NYCERS paid Allegra $2.2M in fees from 2000 to 2010. The fees may be even higher. Since 2005, there are four years with missing fee data. I left NYCERS in 2005.

PCG is reporting a -9.2% IRR for these two exited PE investments. PCG, however, provides no documentation supporting this number.

The only way to calculate an accurate value of a PE investment’s IRR is with the full cash flow history for the partnership. NYCERS members and retirees are entitled to this history. They have the right to a public reckoning of all investments.

When it comes to accurate data, there is a high flight risk with any PE investment. In addition, I have a strong suspicion that NYCERS has been derelict in its responsibility to seek and maintain the necessary information to protect the funds it placed with PE managers.