CalPERS Direct-Style Private Equity Plan Comes Up for a Vote March 18

The largest US pension plan aims to break new ground with a program to expand its private equity asset class.

California Public Employees’ Retirement System (CalPERS) officials are moving ahead with their plan to create a direct-style private equity investment organization that would invest up to $20 billion, and will ask the system’s investment committee to approve the concept at its meeting March 18.

Agenda material shows that the vote is scheduled for that meeting, although the plan wouldn’t be implemented until a second vote and a review by an outside consultant.

If the investment committee approves the plan as expected, the CalPERS investment staff will have the authority to negotiate and hire investment teams for Innovation, which would invest in late-stage companies in the venture capital cycle, and Horizon, which would take buy-and-hold stakes in established companies.

CIO first reported on March 4 that CalPERS Chief Executive Officer Marcie Frost was working with Bill Slaton, chairman of the CalPERS investment committee, to potentially put the resolution creating Innovation and Horizon for a vote at the March 18 meeting,

Frost told CIO that CalPERS needed to send a message to Wall Street.

“We need to cast a wide net to the financial community to say we are serious about this,” she said.

CalPERS officials detailed the need for the new private equity investment organization in the agenda material, noting that the pension plan’s current $27.8 billion private equity program is its best-producing asset class, but that “the current pace of capital commitments and calls is insufficient to have the prospect of increasing the level of exposure to the asset class.”

CalPERS’s private equity program produced returns of more than 16% in the fiscal year ending June 30, 2018, almost twice the pension system’s overall return. CalPERS Chief Investment Officer Ben Meng has said that expanding the CalPERS private equity portfolio is the pension plan’s best chance to achieve its yearly expected average annual rate of return of 7%, helping to decrease the system’s unfunded liability, which is estimated to be more than $135 billion.

The CalPERS private equity program, which is currently made up of mostly co-mingled buyout funds, with CalPERS being just one of many limited partners, is actually shrinking in terms of its portion of the overall investment portfolio. Private equity makes up around 8% of CalPERS’s $351.1 billion portfolio as of January 31, 2018, show retirement plan statistics, down from around 10% of the portfolio four years ago. Meng said in January that CalPERS is competing with other pension funds, sovereign wealth funds, and foundations and endowments for limited spaces in funds run by the top-tier private equity funds.

The agenda material also says that if CalPERS were able to increase commitments through its current program, it “risks an over diversification of managers (simply adding more of them), which could lead to creating an ‘index’ of private equity with likely lower return prospects.”

CalPERS sees Innovation and Horizon as a way around the problem of investing more in private equity, though pension plan officials do acknowledge there are risks.

A separate presentation also to be presented to the investment committee March 18 raises perhaps the key question as to whether CalPERS can successfully launch the private equity organization: whether it can recruit top investment talent, who can “further define and execute (investment) strategies” and “be able to build out new teams from the ground up.”

CalPERS officials haven’t set a timetable for the start of the program, just offering that they will move forward when they have the right investment teams in place and have done the necessary due diligence. The presentation does also say, however, that “the ability to act quickly will mitigate risk of losing (investment) partners who may have other opportunities.”

The line in the presentation is a reference to the investment committee. Even after a successful vote March 18, it needs a second vote to execute the private equity plan once the investment teams are in place.

While most of the 13 investment committee members, who are also CalPERS board members,  support Innovation and Horizon, several have expressed concerns including being potentially rushed to approve the program without seeing detailed financial presentations.

Others have questioned why CalPERS is hiring outside investment teams to run the program. The teams will be funded by CalPERS but will actually operate independently, similar to a general partner-limited partner relationship in private equity. CalPERS will be the limited partner, but it will be a sole partner with the general partner, instead of its normal relationship in a co-mingled fund.

This contrasts to pension plans in Canada that run some of their own private equity programs directly without external managers or general partners. Meng has said that CalPERS does not have the in-house expertise to launch such a program and that Innovation and Horizon are the best way for CalPERS to build its private equity program for now.

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