As treasurer of the City of Chicago, Kurt Summers sits on the boards of four public pension funds. He took office in December 2014 and has led Chicago’s ESG development and implementation project. Since then, the city has more than tripled its annual earnings from $49.7 million in 2014 to $156.1 million in 2018.
Chicago built its own ESG platform, which identified around 170 key factors material to financial performance or to Chicago’s constituents, and assigned them a weight as part of an overall score. The platform was integrated into investment decision-making in the third quarter of last year.
Summers was previously a senior vice-president at Grosvenor Capital Management and a member of the office of the chairman, where he created a new product that invested more than $2 billion in minority- and women-owned firms. Summers will be stepping down as treasurer on 17 May. He has not yet announced his plans.
Summers, a keynote speaker at Private Equity International’s third annual Responsible Investment Forum in New York in March, sat down with sister publication PEI to talk ESG, fees and private equity’s biggest threats.
Having been inside the industry, do you now see it in a different light from your current perspective?
Now I have clarity on why the industry needs to do a better job of leading in its own narrative and leading in reality. You can’t be a large employer in this society and not take on leadership and workforce issues, or income inequality issues, or diversity issues. It’s no more acceptable for private equity to do that than for a Fortune 500 company. And in many cases, private equity fund managers have portfolios that dwarf large public companies, which should make their responsibility that much greater.
That’s where the disconnect lies. As an industry [private equity managers have] not been accustomed to that level of scrutiny in the past. They’ve made their bones taking advantage of doing private deals with private information and protecting that because it’s their competitive advantage. No one should begrudge them that, but that shouldn’t prohibit them from taking leadership roles in society or in the marketplace. Some of the larger private equity firms have done this, some of those also have public management companies, so there are other incentives to do so.
But for the most part, those that are in the mid-market or less in the public eye haven’t taken the initiative. The belief from the public and from the investor community is that they’re going to have to be dragged there kicking and screaming, which is unfortunate.
What would you say to those who question the private equity compensation model?
The debate around capital gains versus ordinary income that has persisted for the last two decades around the private equity industry certainly hasn’t helped this narrative in the public eye. What progressive taxation looks like is a subject of increasing debate in this country, so I suspect that post the 2020 [presidential] elections there’s going to be more attention paid to this issue. It’s less about private equity as an industry, and more about the continuum of wealth creation and what progressive taxation looks like.
As an investor, I don’t believe it’s sustainable for the wealth generated by a company or a fund to be held only by a small group of people. It’s not that they don’t have the ability to create all the wealth they want, but that it may not be sustainable to continue to attract and retain talent in that fund or that portfolio company. If there is a push for fair wages around the country, if we have an issue with the working poor, with poverty and inequality in this country, you just extrapolate that out to know that it’s not sustainable, at a societal or a company level.
Ultimately, talent will vote with its feet; you must have an economic structure that allows you to continue to attract and retain talent, otherwise you won’t retain market share and you won’t retain LPs and you won’t continue to enjoy the fruits of your labour.
Are private equity fees at the appropriate level today?
Fees are appropriate as long as the market is willing to pay them. That said, given how much wealth is created in the industry through the fee structures, I think it has been ripe for innovation and disruption.
I don’t think any dynamic where the consumer feels they’re not getting what they’re paying for is sustainable, whether you’re talking about bottled water, a candy bar or a private equity fund.
If that’s the case across the industry, [investors will] replace private equity with small-cap public equity or a defensive equity strategy or something like that, which for a fraction of the fee will give a comparable return.
Does private equity have an image problem?
I think there’s a disconnect between what the broader public thinks about private equity and the reality about the role it plays in our economy. Private equity plays a significant and important role as an employer, as corporate leaders, and it has an impact on our workforce, on societal issues and on the way we govern and conduct ourselves. I think that that’s not always appreciated by the broader public, but it’s probably the industry’s own fault.
Why has Chicago decided to take such a stand on ESG issues – isn’t it a risk?
I think to go in haphazardly without doing the work would have been a risk, but you’re now looking at the benefit of more than two years of work on this subject. A year just studying all of the sources of data in the marketplace and how certain data elements correlate to performance, risk or volatility, and then a period where we effectively had a shadow portfolio, where we said, ‘If we would have screened looking at this, what would that have looked like? What would our scoring be? What decisions would we have made?’
“You must have an economic structure that allows you to continue to attract and retain talent, otherwise you won’t retain market share”
So, we went into this as much as possible with eyes wide open and with full information and studied it ad nauseam. Because we don’t take our responsibility as fiduciaries lightly, particularly of public taxpayer dollars.
But the real risk was not doing this, to sit there blind to all of these factors that could have a material impact on the quality of our investments, and thus the return or risk we’re taking unknowingly on behalf of taxpayers. I would argue the vast majority of public investors in the US are unknowingly taking these risks, and it’s at their own peril.
How do you ascertain a firm’s commitment to diversity?
The question is: what are the inroads you’ve made to pipeline both experienced and junior hires that can help you, over time, find high-quality talent outside of the traditional network where you’ve been seeking it? Because you’ve clearly been unsuccessful there.
To have the expectation that things change overnight is unreasonable, but I think it is reasonable to say that making that change is tied to the compensation of your senior management team, that over time, performance evaluations for your senior managers will incorporate their own commitment to diversity, mentoring and search for diverse candidates.
Are you willing to pass up commitments to funds who are not making a commitment to diversity?
Yes, we have done that. We do that all the time. There are a lot of great firms out there. If there are 1,000 private equity firms, 250 are top quartile, or if there are 100 in this strategy, 25 that are top quartile, 10 are top decile. So you still have to differentiate. All of them will say, ‘We’re bigger, and that’s what makes us better,’ or, ‘We’re smaller and more nimble, that’s what makes us better,’ or, ‘We have this secret sauce or that secret sauce.’
Increasingly, questions are being asked explicitly in areas of ESG, around how those get incorporated or what past experiences have been. Trustees of pension funds are being educated around the types of questions to ask. We have examples of funds that, because of worker safety issues or workforce relations or lack of diversity, all have not gotten allocations relative to peers who didn’t have those issues or who had better answers to how they’re addressing them.
The four pension plans you’re on the boards of have very different exposures to private equity. Why is that?
One reason is liquidity. The Municipal Fund in Chicago, for example, has a 22 percent funded status. It’s not advisable to take on additional illiquid investments until we have dedicated funding streams for us to get back to a healthy funded plan.
The Police Fund, by contrast, does have a dedicated funding stream, even though it’s also on the lower end of funded plans in the country, so it can look more expansively at alternatives.
As is the case with funds around the country, it also varies by sophistication of the team, political will and experience. Some funds have been burned by bad investments in the past and it makes them gun-shy to pursue similar investments in the future.
Also, the actuarial required rate of return in some cases pushes up private equity exposure, because it’s an asset class where you can generate alpha relative to the public markets. If you have a discount rate of north of 7 percent, there’s more pressure on you to invest in alternatives.
Has private equity been an alpha generator for those funds?
The experiences vary by fund. They haven’t all invested in the same fund managers, and because of the liquidity issue they haven’t been able to invest year after year in different vintages. Those funds that have had enough dry powder for a more consistent investment programme have performed better than those who have invested more sporadically.
How are those funds preparing for the downturn?
In some cases we’re looking at more defensive equity strategies, where available investing in more real assets and infrastructure as an inflation hedge, where possible investing in more liquid strategies, even as it relates to alternatives to give us the flexibility. We’re negotiating stronger side letters for lock-ups and things like that if there’s a real problem. We’re investing more, in some cases, in private credit versus public fixed income, just to give us flexibility on terms.
What’s your biggest concern for the asset class?
I’m concerned fund managers have the ability to pursue creative disruption of the industry, but they don’t take advantage of that. Then you’ll have some folks who become extinct, and a new set of players we may not have even identified yet transform what the market looks like.
I think, generally speaking, the mega-players are going to be fine, they’re diversified enough both in terms of their product offering and their investor base, and they have the resources to innovate, with some already starting to do so. But there’s a lot in between them and the smaller innovators that can become extinct if they don’t grab the wheel.
We’ve seen this in so many industries: insurance, banking, healthcare, virtually every consumer product, technology. And we’ve actually seen it in asset management with the growth of ETFs and passive strategies. This isn’t any different.
I’m equally as excited as I am concerned. I’m excited for those that seize it, and if I were in the industry, I’d be all over that. I’m concerned for those who are sticking their head in the sand.