The nation’s two largest backers of private equity firms are fighting back against a state legislative proposal that threatens to restrict their ability to invest in brand-name mega-funds.
The California State Teachers’ Retirement System went on the offensive earlier this month, voicing its opposition to a bill that would bar state-run pension funds from backing funds managed by buyout firms that are owned partially or wholly by sovereign wealth funds affiliated with countries that haven’t signed certain human rights treaties. The California Public Employees’ Retirement System, whose board was scheduled to meet on March 17, is expected to follow suit.
Both pension funds, which have staked out reputations as two of the most socially conscious limited partners in the country, said they anticipate that the bill would cost them both a significant amount of revenue. CalSTRS estimated the bill’s passage could cost it between $1.5 billion and $5.3 billion in lost investment revenue over five years. At press time, CalPERS’s staff was still preparing an analysis of lost opportunity.
At issue is AB 1967, introduced last month by California state Rep. Alberto Torrico, a Democrat from Newark, which is located across the San Francisco Bay from Silicon Valley. As private equity firms have increasingly ranged the globe in search of LPs, a handful of the biggest buyout firms have sold pieces of their management companies to sovereign wealth funds.
Apollo Management and The Carlyle Group are just two firms that would by subject to Torrico’s legislation. Last year, Apollo group sold a 9 percent ownership stake in its management company to the Abu Dhabi Investment Authority, while Carlyle Group sold 7.5 percent of itself to Abu Dhabi-based Mubadala Development Corp.
Last year, the two firms contributed to an increase in the value of CalSTRS’s portfolio, which posted a 33 percent return on its private equity investments. Private equity similarly outperformed for CalPERS, which also owns pieces of Carlyle Group and Apollo Management and invests in their funds. CalPERS’s private equity portfolio generated a 26 percent return in 2007.
The low-end cost estimate of $1.5 billion over five years assumes CalSTRS must only decline to make new investments in Carlyle Group and Apollo Management. According to the estimate, the pension fund would shift the money it expects to commit to the two firms into investments in public equities, generating a 7.5 percent return.
The $5.3 billion estimate, however, is the “worst-case scenario,” said CalSTRS spokeswoman Sherry Reser. That calculation assumes that CalSTRS won’t be able to follow through on 70 percent of its anticipated “top-tier” buyout firm commitments as more shops seek to sell pieces of themselves to overseas interests. The estimates exclude The Blackstone Group, which, as a publicly traded company, isn’t subject to AB 1967.
Beyond potentially losing big bucks, both pensions could become far less attractive LPs if the bill passes. That’s because 60 days before making an investment decision, they would be required to evaluate and write detailed reports about the involvement of government funds that aren’t banned by the bill. “These (top buyout firms) have no trouble raising new funds, and we’re on top of the list of potential investors right now,” said Reser. “If you layer in all this research and reporting and public disclosure, we’ll stop being an investor of choice.”
It could become a major hurdle for CalSTRS and CalPERS. According to the U.S. Congressional Joint Economic Committee, the 39 largest sovereign wealth funds command combined resources of $3.2 trillion, money that the buyout firms are increasingly seeking to tap.
Passage of AB 1967, which is still wending its way through through the state Legislature, wouldn’t be the first time that CalPERS and CalSTRS become constrained by perceived social risks. Last October, California Gov. Arnold Schwarzenegger signed legislation that gives the pensions until January 2010 to divest billions of dollars of stock in energy companies that do business Iran. That list includes Brazilian oil company Petrobras, Russian oil producer Gazprom, and multinational Royal Dutch Shell. CalSTRS estimates that piece of legislation will decrease revenue by $130 million to $200 million annually over the next five years.