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Blood money, or smart investment? Kentucky Retirement Systems owns a stake in assault rifle maker Colt Defense

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Colt Defense makes the M-4 assault carbine, used here by U.S. Army soldiers in Iraq. Colt also makes versions for U.S. consumers. (Photo by Terry Boyd.)

At a time when investment groups and retirement funds are backing away from arms manufacturers, Kentucky’s retirement systems finds itself in a tight spot.

KRS indirectly holds assets in the weapons manufacturer Colt Defense LLC, through investments in Blackstone Group funds.

Blackstone Group, based in New York City, is a massive financial conglomerate – part Goldman Sachs-style financial services, part M&A firm, part leveraged buyout firm and part hedge fund. Blackstone has about $150 billion under management – not the biggest financial power, but nonetheless a significant market maker.

(By comparison, Warren Buffet’s Berkshire Hathaway has roughly $400 billion under management.)

Through its Blackstone investment, KRS has a stake in weapons manufacturer Colt Defense, which is not unusual considering the global arms trade is among the largest businesses on earth, worth an estimated $50 billion annually.

But post-Sandy Hook Elementary School, will the Kentucky Retirement Systems and other state public employee pension funds follow the lead of California, New York and other states and divest out of funds, private equity groups and other institutional investment options invested in weapons manufacturers?

Or will it be business as usual in a state that is virtually owned by the National Rifle Association, the dominant Gun Lobby group?

And in practical terms, which strategy offers the optimal future financial returns for the retirement funds, which are already among the most precariously underfunded in the United States?

Since the December 14 Sandy Hook killings, investments that touch the firearms business are increasingly problematic. A topic so sensitive, we didn’t get a lot of cooperation from KRS officials when we asked about KRS holdings.

When Insider emailed KRS officials asking if any KRS funds were invested in weapons manufacturers, T.J. Carlson, KRS chief investment officer, responded, explaining why he couldn’t answer our question:

…the definition of ‘weapons manufacturer’ means different things to different people.

KRS Trustees Tommy Elliott, Timothy Longmeyer, Jennifer Elliott, and Dan Bauer have not yet returned our emails sent last week.

Illinois public pension fund managers are not as hush-hush as KRS. As reported in the Chicago Tribune, Illinois State Board of Investment Executive Director William Atwood has said the state’s public pension funds are invested in three gun-makers: Olin, Sturm Ruger and Smith & Wesson, and they’re reviewing those investments.

Here’s what we know, from KRS filings:

From KRS’s Comprehensive Annual Finance Report for the period ending June 30, 2012, KRS held about $64 million in Blackstone Capital Partners V & VI, and about $467 million in Blackstone Alternative Asset Management (BAAM).

Blackstone bought a $30 million equity stake in the privately held Colt Defense LLC in 2007.

Carlson did give us insight on KRS investments in the gun industry:

Consistent with carrying out their Fiduciary Responsibilities and the concept of Modern Portfolio Theory, the Trustees will not systematically exclude any investments in companies, industries, countries, or geographic areas unless required to do so by statute.

Which is a statutory requirement for most state pension funds, with trustees required to invest in profitable companies without regard to political or social ramifications.

However, guns have become more of a public-relations issue for institutional investors since the Newtown, Conn. killing, which included 20 first-graders.

Last week, Cerebrus Capital Management, a private equity firm/hedge fund, announced it was selling the Freedom Group, a company that makes the AR-15 Bushmaster assault rifle used in the Newtown rampage.

(If Cerebrus sounds familiar, the firm used to own a significant stake in Chrysler.)

In their statement about the divestiture, Cerebrus executives called Sandy Hook “a watershed event” that has raised the national debate between public safety and the scope of the Constitutional rights under the Second Amendment. The firm is about investment, not public policy, they wrote.

Then they added:

There are, however, actions that we as a firm can take … We believe that this decision allows us to meet our obligations to the investors whose interests we are entrusted to protect without being drawn into the national debate that is more properly pursued by those with the formal charter and public responsibility to do so.

Cerebrus executives made the move after pressure from the California State Teachers’ Retirement System – one of the nation’s largest teacher pension funds – and the State of New York.

City of New York Public Advocate Bill de Blasio, who is a trustee of one of New York City’s public pension funds, is publicly asking for all five of his city’s five public pension funds to withdraw their investments in firearm and ammunition stocks. Blasio is also encouraging public pension funds across the country to do the same.

Kentucky is unlikely to follow suit for practical reasons, as much as political. Closing out of an investment can take years, according to an ABC News.com post. It took the State of New York two years to close out an investment in Iran, for example.

If the Kentucky General Assembly needs to pass a statute before KRS can divest out of weapons manufacturing, that may be complicated, starting with a clarification that must be made when talking about Colt, the company.

As explained in a 2011 profile of Colt by the American Rifleman, the official NRA magazine:

… Colt Defense LLC, a defense oriented business and Colt’s Mfg. Co. LLC, a commercially focused business. These are two separate, yet affiliated, legal entities, both of which are owned by private equity investors. For Colt Defense LLC, the largest is Sciens Management LLC (54 percent), followed by a fund advised by The Blackstone Group (24 percent), and then CSFB SP III Investments LP (9 percent).

In a nutshell, the pension funds of Kentucky public employees are not, that we are aware, invested in the commercially focused arm of this weapons manufacturer, but only the “affiliated” defense arm.

Does that make the Colt investment less controversial?

Before you answer, consider how “affiliated” Colt Defense and Colt Manufacturing really are.

From the latter’s website:

Colt’s rifles are the only rifles available to sportsmen, hunters and other shooters that are manufactured in the Colt factory and based on the same military standards and specifications as the United States issue Colt M16 rifle and M4 carbine.

Colt Defense LLC sells weapons in 94 countries, including Iran. Colt lists Yugoslavia as a customer, which hasn’t even existed since 2003.

The Colt-made AR-15, (M-16) is a one of the top-selling assault rifles in the world, behind only the ubiquitous AK-47 and the G-3, made by German manufacturer Heckler & Koch:

Red indicates countries where the AR-15 (M16) has been sold.

So, this is a global issue that connects back to Kentucky’s public employees.

The ultimate question is whether – divorced from Newtown – KRS and other funds should stick with their investments in gun manufacturers can be debated.

Some companies, such as Austrian military pistol manufacturer, Glock, are legendarily profitable, with a profit margin estimated at more the 50 percent per firearm.

That’s not always the case.

Media reports state Freedom Group lost money four of the last five years even though demand for “sporting weapons” such as the AR-15 has grown by more than 20 percent since 2007.

The increasing chance of legal restrictions on guns may mean institutional investors might begin to cut their exposure to the industry.

Ultimately, Kentucky retirement funds’ indirect ties to gun makers might resolve itself without KRS officials doing anything as investment firms look to get out from under the Newtown publicity nightmare.

According to MSNBC, Blackstone spokesperson Peter Rose said last Tuesday that Blackstone has “planned for a long time” to end its relationship with Colt Defense, though he said the firm has no timetable for doing so.

Last Wednesday, the financial services group Cowen & Company downgraded Smith & Wesson from a rating of “outperform” to “neutral” on the expectation of tighter regulations on firearms.

An intriguing question is, could/should KRS have avoided investment in Blackstone/Colt all together?

Investment expert Chris Tobe was a KRS Trustee himself until he turned whistleblower and was replaced.

We asked him about KRS’s investment in Blackstone, and found out he’s not really a fan:

I have been very troubled by KRS investments in Blackstone, and was the only trustee not to vote for investing over $400 million with them in a hedge fund earlier this year. My main concern was investing with a firm that was still part of an ongoing SEC investigation at KRS on placement agents, but other issues such as the CEO throwing $3 million parties for himself, animal cruelty charges at  Sea World, all fit the pattern of Wall Street Greed that the fact they invest in assault weapons is no surprise.

Blackstone’s CEO is Steve Schwarzman, who indelicately compared President Obama’s efforts to raise taxes on private equity firms to Hitler’s invasion of Poland.

Tobe tells us four of the KRS transactions under still SEC investigation involve the placement agent firm Park Hill, a Blackstone affiliate.

Two of four transactions brokered by Park Hill were for the purchase of $225 million in Blackstone funds, $100 million in 2008 and $125 million in 2006. 

Blackstone’s investment in Colt could prove less an issue for KRS officials than how and why KRS came to be invested in Blackstone in the first place.

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