AFSCME District Council 36

LACERA Board of Investment Meeting for February 8, 2017

Article By: Fred Massey

Good News. LACERA now has $59 billion in assets. The Interim CIO believes that the rate of return will improve in the coming years. The Board focused on reviewing three proposals for actuarial services. Stepstone, discussed repatriating investment money from China.

The LACERA Board of Investment has initiated the Request for Proposal (RFP) to contract with actuarial firms to provide actuarial consulting services and actuarial auditing services for the Board. The Board is prepared to sign a five- year contract for services with two one year extensions. The staff was hoping to get numerous candidates to offer their service but only three firms did. Milliman, Segal and Cavanaugh Macdonald did respond to the RFP. Each company has responded to the RFP and provided a detailed description of the services they are prepared to provide and the fees for service. These firms are offering to provide five years of service for about $2,500,000 for actuarial services and another $700,000 for the auditing services. When the BOI want a special report or ancillary services, these firms will charge $450 to $495 per hour for these services.

The three companies offered to provide both consulting services and auditing services. Both Milliman and Segal provided services to LACERA under existing contracts. Milliaman provides consulting services and Segal provides auditing service. They have for many years. In the fall 2016, Segal began providing consulting services for the Retirement Health Care Fund under the Board of Retirement. The problem for the Board was that the three candidates were now offering to provide both services. They were asserting that they could do this without creating a conflict of interest. Both the Board and staff recognized that they could not. The Board and staff decided that they could retain Milliman and Segal without creating a conflict of interest. Because Cavanaugh Macdonald had not provided services, they could be hired without creating any conflicts.

BOI received a presentation from StepStone, LACERA’s Private Equity Consultant, on the repatriation of money from investing in the People’s Republic of China (PRC). On two prior occasions, the Board heard from other experts on investing in China. One presenter was a lawyer for a firm that specializes in China. The second presenter was from a firm that creates investment vehicles that buys and sells Chinese stock through an index fund scheme. So, this is the third presentation on some aspect of investing in China in two or three years.

What drives the Board’s concern and focus on investing in China? There are three reasons why investors are interested in investing in China. First, China is the second largest economy in the world and soon will be the largest. Second, it has the largest population. Third, China’s economy has grown at a rapid pace in the past two decades.

While China appears to be an attractive place to invest, the investment environment presents challenges. The government has slowly opened itself to foreign investment. While the People’s Republic of China has opened its economy to foreign investment for over two decades, foreign investors continue to have questions about China’s political system and its economy. Economic information is not always complete and reliable. The government continues to have numerous controls over the operation of the economy. The companies that are listed on the stock exchanges do not provide complete information to potential investors and stockholders. The lack of transparency contributes to the problem.

The currency, the Renminbi (RMB), is carefully managed by the People’s Bank of China, the Central Bank. The currency is managed through a managed float. The RMB trades within a price band against a basket of other currencies. The US Dollar and the Euro are freely exchanged with other major currencies. The central bank has created a cumbersome process for foreign nationals to recover their money. The point is this: outside investors have many concerns about investing in China and there is a lot of anxiety about it, particularly repatriating investment capital.

StepStone’s presenter described how private equity money flows into China and how the money is repatriated when the assets are sold. Foreign investors may invest in China using two investment structures: The Variable Interest Entity (VIE) and the Joint Venture (JV). The VIE is a general partner domiciled in the Cayman Islands and is listed on a stock exchange. This company invests in a second company located in Hong Kong. This second company invests in a wholly foreign owned enterprise (WFOE) in the Peoples Republic of China (PRC). This Chinese based company lends money to a PRC individual who in turn establishes a domestic operating company. The PRC owner makes a profit and pays the WFOE. This company pays the Hong Kong based company who in turn pay the Cayman Island based general partner. If this seems convoluted and complex, it is.

Although there are a number of hurdles to get over, the VIE is in common use. Since 2000, over 1000 Chinese companies have used this structure to secure foreign investment in their enterprises. Alibaba, China’s Google, has used this structure and now trades on the New York Stock Exchange.

The second structure is the Joint Venture (JV). It is formed by foreign investors and Chinese Company. The foreign owner has more than 25% of the capital invested. The partners create a limited liability corporation. The parties have a written agreement about how the profits and losses are shared. The JV is able to sell its assets in China, often as a publicly held stock company through an initial public offering. Both the JV and the VIE are regulated by the same laws.

When the dividends and the profits are sent out of the county, the money transfer requires the approval of a state banking institution, the State Administration of Foreign exchange, and the Ministry of Commerce (MC). The MC collects the taxes and assorted documentation need to close out the sale. After clearing these hurdles, the investors need to have the money to clear through the central bank. When the RMB is strong, the repatriation may only take up to 30 days and if the RMB is weak against foreign currencies, the repatriation may take up to 60 days.

This presentation provoked a lively discussion. Mr. Kehoe, a sheriff deputy and an elected member representing public safety employees, told the Board that the repatriation process sounded like a money laundering scheme to him. Kehoe’s comment got a laugh from the Board, staff and the public present. Other Board members thought that China is headed into an economic downturn. Mr. Kehoe also was concerned about public order in China. Young people are restless and there is a decline of public order. LACERA, like most pension boards, does not have a political consultant to evaluate political risk in foreign investing. They rely on the general partner’s view.

Before the meeting closed, the Acting Chief Investment Officer announced that BOI now has $50 Billion in assets under management. The Acting CIO felt that the average rate of return on LACERA’s assets will improve dramatically in the next two years after the poor results from 2008, 2009, and 2010 are no longer a part of the average rate of return calculus. Mr. Schneider, one of the more conservative board members, did not agree with the CIO because he expects an economic downturn in the next few years that will pull down the average rate of return.

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