Pension Fund Managers Hit by Mysterious Rash –

A rash is spreading across the nation. California, Colorado, Florida and Wisconsin have already been hit. Who will be next?

The rash means itchy feet for top private equity portfolio managers at public pension funds. Early reports indicate that portfolio managers become susceptible to the skin condition after they get calls from headhunters offering jobs that pay 10 times more than state-run organizations.

Among those recently hit by the condition are Rick Hayes of the California Public Employees’ Retirement System (CalPERS) and Frank Fernandez of the Florida State Board of Administration. Both of them left their public sector posts last month to take on similar roles in the private sector. Six months earlier, the Colorado Public Employees’ Retirement Association lost its top private equity portfolio manager, and the State of Wisconsin’s Investment Board bid farewell to its chief investment officer.

The tide of top-tier professionals leaving the public pension funds, and the funds’ inability to draw in new talent, bodes ominously for the retirement funds. Managers are leaving the public sector to make more money. Money attracts and retains talented managers. If public pension funds cannot reform their compensation systems, it’s a rut they’re not likely to get out of anytime soon.

“When you’re at the table negotiating, sitting across the table from someone who makes 10 times more money than you, wouldn’t you want to get there eventually?” asks Adam Zoia, the founder and managing partner of New York’s Glocap, a New York City-based executive search firm that tracks compensation for the private equity industry.

Compensation is equitable at the junior level for private equity firms and public pension funds. Analysts, and often associates, in both places make between $40,000 to $50,000 annually, according to one New York-based private equity industry recruiter.

Gap Widens

But as those associates move up the ranks, the salary gap between the private sector and the public side becomes wider. In 2001, a general partner at a private equity firm that manages at least $1 billion took home more than $1 million year, on average, according to the 2003 Investment Benchmarks Report published by Glocap and market researcher Thomson Venture Economics (publisher of VCJ). The total compensation includes an average salary of $676,000 and a bonus of $418,000. That figure doesn’t take into account the typical 20% carried interest the GP receives or the co-investments he or she makes. If the GP were at a successful firm, he or she would take home multiple millions of dollars a year.

On the other hand, David Mills, the new executive director for the State of Wisconsin Investment Board, will receive an annual salary of $225,000. In his position, Mills oversees a $63.8 billion investment pool. His predecessor stepped down in December. Patricia Lipton had received $215,000 annually to lead a team of 104 staff members at SWIB.

“Compensation has always been a concern for every state pension,” says Mike McCauley, director of investment services and communications at Florida’s $120 billion state pension fund. “It’s not apples to apples. Compared with opportunities in the private sector, recruitment and retention has always been a problem.”

When Hayes’ predecessor, Barry Gonders, left CalPERS in 2001 to join Grove Street Advisors, he acknowledged that money was a motivating factor.

California’s pension funds confronted the issue head on last year. After much internal debate, the state’s two largest pension funds, CalPERS and CalSTRS, pushed a bill through the state legislature that brought compensation for its portfolio managers closer to the industry standard. Before, state investment officers were compensated at a rate similar to that of all civil servants.

“It’s like a food chain,” says one New York-based analyst who monitors salaries in the private equity industry. ” If you’re good, you’re always being recruited up in the food chain.”

To be recruited does not translate into a new job description for public fund managers. Portfolio managers at public pension funds are not being recruited to scout deals, perform due diligence or sit on company boards. They’re being recruited to sift through fund prospectuses to build a fund-of-funds or leverage their relationships to raise money from public pension funds.

Florida’s Fernandez left his job as a senior portfolio manager to join Alignment Capital, an Austin-based private equity consulting group that is about to begin fund-raising for its first fund-of-funds. That fund has a target of $300 million. Fernandez is scheduled to start work on July 1.

Like Fernandez, CalPERS’ Hayes will set up a fund-of-funds business for Oak Hill Partners, a 20-year investment group that manages $10 billion of Robert Bass’ oil fortune. There are other investors in Oak Hill’s funds, says an Oak Hill spokesman, and Hayes’ new business is also likely to add limited partners to capitalize the fund-of-funds. Details, however, are still hazy. No word yet on how much Hayes’ group will manage, what types of funds it will invest in or who will work for him. Hayes starts his new job July 1.

Kevin Kester, the former head of the Colorado Public Employees’ Retirement Association’s $3 billion private equity group, joined the Broe Cos. in December to fill a position much like the one Hayes has taken. Broe is a diversified investment group in Denver that controls $1 billion. Broe buys real estate and distressed companies and invests in the transportation sector and retirement communities. It recruited Kester when it decided to reach deeper into the capital markets and build a portfolio of equity partnerships.

Not Alone

Publicly owned pension funds aren’t the only ones losing investment professionals to the private sector. Mark Yuskow, president and chief executive of the University of North Carolina’s $1 billion endowment, announced his resignation in April. He is expected to resurface on the private side later this month.

None of those pension funds have yet been able to pull anyone from the private side in, forcing them to draw from a limited pool of internal talent. Jim Trainer TK is expected to take over Fernandez’ position in Florida. His appointment will likely be announced later this month. SWIB’s Mills was an internal hire, as was Chris Reilly, who stepped in to take over from Kester in Colorado in January.

If the public pension funds cannot find the cash to recruit and retain top managers, they’ll be hit by a rash of itchy feet every time the private equity markets swing into fund-raising mode. Private equity firms need the expertise and relationships that come only from someone who’s been on the inside to raise funds in a competitive market. It’s not just a few careers on the line. What’s at stake is the pension funds’ ability to build a focused private equity portfolio with a clear vision for the long term.