CalSTRS Takes First Steps to Restructuring Private Equity

The pension plan is getting ready for investments out of the traditional limited partner-general partner fund structure, including increases in co-investments.

The investment committee of the nation’s second-largest retirement plan, the California State Teachers’ Retirement System (CalSTRS), is expected to give approval later this month to a partial restructuring of its approximate $18.5 billion private equity program, the first step in what could be some major changes to the fifth-largest pool of invested private equity capital in the US.

The expected private equity revisions for the $228 billion CalSTRS have been overshadowed by the retirement plan’s neighbor, the Sacramento-based California Public Employees’ Retirement System (CalPERS). CalPERS is expected to implement a $13 billion direct investment private equity organization by early next year.

The $350 billon plus CalPERS, the largest US retirement plan, also has the largest total of private equity investments in the US, $27 billion.

CalSTRS officials are still studying what changes to make to the private equity program, but documents and statements show the system is seriously considering a major boost to alternative private equity investing. That would mean expanding investments out of the more traditional private equity fund structure in which CalSTRS is a limited partner with other investors in a fund run by a general partner.

At the Sept. 21 meeting, the investment committee is expected to approve a new grouping for private equity called longer-term strategies. CalSTRS Chief Investment Officer Chris Ailman cited as an example at the July 20 investment committee meeting longer term buy-and-hold strategies, which he said was way to grow the entire private equity portfolio.

The CalSTRS portfolio has an 8% allocation to private equity, something system officials would like to grow, but have been unable do in the competitive institutional market for private equity investments.

“We see this more as sort of buy-and-hold kind of private equity instead of trying to buy the company for just five to seven years [a traditional private equity fund cycle] and then sell it, a buy and hold for maybe 10 to 20 years,” Ailman said at the July 20 meeting. “And we think that makes a lot of sense.”

Ailman mentioned Japanese financial giant SoftBank’s $100 billion fund to buy investments in late-stage venture capital companies.

“So, we think it’s going to be a real interesting area,” Ailman said. “It’s going to have a different return profile than traditional private equity because [there’s] not as much leverage, but it actually fits our liabilities better and it’s much longer holding periods.”

Ailman’s comments echoed what its neighbor CalPERS plans to do. CalPERS’s proposed direct investment plan consist of two direct investment organizations: Innovation, which would invest $10 billion over the next decade in late-stage venture capital investments, and Horizon, which would invest $10 billion in more-established companies in a buy-and-hold strategy.

Ailman declined requests for an interview and it’s unclear how CalSTRS’s program would differ from that of CalPERS.

However, in another remark, Ailman said that the CalPERS Horizon buy-and-hold strategy is aimed at investing like Warren Buffett. “I am not sure you’re going to be able to copy [his top-notch investment results], but good luck to them.”

Ailman added that he is covered by a CalPERS pension. CalSTRS only gives pensions to educators.

Part of what CalSTRS has been exploring for private equity is a collaborative model, in which the pension system joins with other asset owners to invest in private equity, saving the normal 1% to 2% management fee and 20% profit cut that goes to private equity general partners.

The collaborative model, along with the investments in the longer-term private equity strategies, is being studied by the CalSTRS investment committee, but a full report is not expected until the late spring at the earliest.

The only thing that seems clear is that CalSTRS plans a much larger co-investment program. This is where institutional investors invest alongside private equity funds, making investments in portfolio companies in separate accounts. Those investments are often offered by private equity general partners at no fee, enabling a pension fund like CalSTRS to take a stake in an investment in a portfolio company beyond their fund investment.

Earlier this year, CalSTRS hired AlpInvest Partners as a co-investment advisor to look for more co-investment opportunities for the pension plan.

Margot Wirth, CalSTRS’s private equity director, told the investment committee at the July 20 meeting that she expected the amount of CalSTRS’s co-investments would go up.

“We’re thinking about doubling our co-investment rate in the next three years,” Wirth said.

Co-investments make up approximately 7% of CalSTRS’s private equity portfolio.

CalSTRS reported a fiscal year return of 9% for the 12-month period ending June 30, but private equity results were 13.8%, its best-producing asset class. The private equity returns lag one quarter, so they were as of March 31.

Over the longer three-, five-, and 10-year periods, private equity has also been the pension system’s highest-returning asset class.

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