Eliopoulos: Without Direct Investment Model, CalPERS’s Private Equity Class Will Shrink

CIO tells investment committee there aren’t enough top-tier firms to invest in to sustain growth.

Chief Investment Officer Ted Eliopoulos warned the California Public Employees’ Retirement System (CalPERS) Investment Committee Monday that the retirement plan’s best return-producing long-term asset class—its $27 billion private equity program—will shrink without a restructuring that would allow direct investments in private equity and venture capital.

Eliopoulos’ comments are a part of a major attempt by the top management of CalPERS to convince the system’s investment committee on the merits of starting an independent organization that would invest billions into later-stage venture capital companies in technology, life sciences, and healthcare. A second part of the program by CalPERS, the largest defined benefit retirement plan in the US with more than $350 billion in assets, would be to make direct investments into corporations in a buy-and-hold strategy.

Investment committee members gave general support to the plan in public comments Monday, but the investment committee has yet to approve the plan. A vote is expected before the end of the year.

The plan is a first for a US public retirement system and was revealed publicly last month.

Eliopoulos said that without the direct investment proposal, CalPERS’ private equity portfolio could shrink to 5% from the current 7.7% of the overall portfolio. He said that was because there weren’t enough top-tier private equity funds to invest in due to intense competition from other institutional investors wanting to be part of the asset class.

CalPERS’s interim private equity target is 8% of the portfolio, but ultimately CalPERS officials want to get up to 10% of the total portfolio for private equity investments.

They envision a way to do that is the direct investment organization, since investors would solely be looking at CalPERS’ interests in their capacity working for an entity set up by the pension plan. The direct investment effort, known as CalPERS Direct, would initially invest as much as $13 billion.

Eliopoulos said the difference between having a 5% private equity allocation and a 10% private equity allocation over the next two decades, assuming CalPERS meets its return objectives for the asset class, could be additional investment earnings of $15 billion to $20 billion.

Private equity is the only asset class that CalPERS expects to earn an average return of over 7% on an annualized basis for the next decade. Even then, the pension system expects to earn an 8.3% return, which is below the more than 9% return over a 10-year period that was estimated for the asset class back in 2013.

While stocks have propelled CalPERS’ returns over the last several years, it has been private equity that has delivered the best long-term returns for the retirement system.

For all longer time periods, ranging from three to 20 years, CalPERS private equity asset class has outperformed the system’s other major asset classes: equities, fixed income, and real estate.

CalPERS private equity portfolio had a 10.8% return for the three-year period ending April 30, 2018, 12.1% for the five-year period, 8.7% for the 10-year period, and 10.7% for the 20-year period.

At Monday’s meeting, CalPERS CEO Marcie Frost and Ashby Monk, executive director of the Stanford Global Project Center, who was invited by CalPERS to speak, also discussed the benefits of the direct investment model.

“We are looking at an opportunity to really put us first in the United States,” said Frost.

Monk said institutional investors are all chasing the same private equity funds, meaning general partners can keep fees high, “using more tricks than I could fit into a 20-minute conversation.”

Private equity general partners generally charge a 1% to 2% management fee and take 20% of profits.

“Everybody you know in the world is ramping private equity exposures,” he said. “So, there’s a flood of capital coming to private equity. Into the 1990s it was something like 5% of pension in America was in alternatives. And that number today is approaching 30%. And that directionality will continue… I’ve seen sovereign funds around the world looking to get 50% of assets” in private equity.


Monk noted CalPERS had paid $700 million in private equity fees and carried interest, profit splits with private equity firms, in the fiscal year ending June 30, 2017.

“The take-it-or-leave-it mentality [from general partners] has probably gotten worse and will continue to get worse unless you break out,” he said. “You can continue to do what you’re doing. That $700 million number will go up.”

CalPERS Board President and Investment Committee member Priya Mathur expressed support for the direct investment program at Monday’s meeting. She said the CalPERS private equity model involves being limited partners in private equity funds in which portfolio companies are sold every five, seven, and 10 years. “We should be owning companies that we are going to deliver value over the long term for a very long term,” she said. “And that’s what I think, in my opinion, is one of the major advantages of this approach.”

But not all board members agree.

CalPERS board member Margaret Brown said she still has not been given any information from CalPERS officials explaining the economic feasibility of the program.

“I have yet to receive any data or analysis,” she told CIO in an interview. Brown said she remains skeptical about the program, particularly in the absence of solid data.

CalPERS officials have acknowledged that the fund would likely have to pay top-dollar compensation packages that could potentially entail millions of dollars per employee in some cases, to attract top-tier investment teams in the direct investment program.

The push for direct investments comes as CalPERS is only 71% funded. Cities, school districts, and the state that contribute to the system on behalf of employees are paying higher contributions. The higher contributions come as the system attempts to increase its funding and because its yearly rate of return has been reduced to 7% from 7.5% due to lower future return assumptions.

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