Board members want CalPERS to start co-investing

California Public Employees’ Retirement System board members are pushing for the system to start co-investing in private equity, even if it means rewriting rules to enable staff to move decisively when opportunities arise.

The $362 billion pension discussed co-investments at its April 15 meeting, a month after getting preliminary approval to pursue a novel PE restructuring.

The investment committee in March voted to allow CalPERS to explore creating two PE vehicles in which CalPERS would be the sole LP. But committee members also want to pursue co-investments alongside traditional fund investments.

Board member Margaret Brown said she wants CalPERS to not only pursue co-investments but also to build up the skills that could lead to sourcing deals and acting as a more sophisticated co-investment partner.

“Hopefully we get to where we are doing a lot of the work in-house,” Brown said. “When we co-invest alongside with our private equity investments, because we don’t pay fees or [carried interest], it helps the overall return for the portfolio.”

Investment staff offered a general summary of the marketplace for co-investments, but pushed much of the discussion of CalPERS’s thinking on the issue into closed session. CalPERS staff did not discuss its co-investment activity or plans in open session until Brown asked.

“We can talk about that more in closed session,” acting PE head Sarah Corr said. “But the short answer is we are not currently doing any co-investment.”

CIO Ben Meng was similarly reluctant to discuss CalPERS’s plans in open session. When Board Member Dana Hollinger asked whether CalPERS staff could quickly make decisions on co-investment opportunities, Meng said CalPERS could not.

But he deferred Hollinger’s question about potential changes to investment-staff authority until closed session.

“That’s what we intend to bring up this afternoon, what we need from this board,” Meng said.

Meng also declined to answer a question in open session from Comptroller Betty Yee about his faith in CalPERS’s ability to perform due diligence and quickly meet GPs’ execution requirements.

The amount of material pushed to closed session drew a rebuke from a retired prosecutor, David Soares of Retired Public Employees Association, who spoke during the public comment portion of the meeting.

Soares said California law requires CalPERS to consider most investment matters in open session, unless the discussions would jeopardize an investment’s execution or value.

In open session, Meng discussed rewards and risks of co-investments generally. He said co-investments could be a way for CalPERS to maintain or increase its exposure to PE and to get better fee-adjusted returns. But in the current market for co-investment, GPs can afford to be choosy.

“Simply put, demand for co-investment from LPs outstrips supply by GPs,” Meng said.

GPs look for LPs that can provide quick decisions and cash, and that can help the portfolio companies in other ways, such as providing relevant expertise in operations and marketing, according to Meng.

They also use co-investments as a way to chase larger deals, since many PE funds have limits on how much of a fund’s capital can be concentrated into a single portfolio company.

Co-investments can provide LPs like CalPERS with more information about underlying companies, and more control in terms of governance at those companies.

On the other hand, being closer to a portfolio company brings risks as well, including headline risk and concentration risk, Meng said.

Adverse selection is a potential risk, as well, but Meng said that there’s little evidence that GPs routinely offer up less-attractive deals as co-investments, while holding onto the better deals for themselves.

Co-investments can also demand more time and resources from investment staff and require quick turnarounds that LPs may not be comfortable with, Meng added.

Action Item: View slides from CalPERS’s presentation on the co-investment market here: https://bit.ly/2UjPAvd