CalPERS Advisor Warms To Turnaround Funds

The $247 billion California Public Employees’ Retirement System agreed in December to increase its target allocation to private equity to 10 percent from 6 percent, or from $14.8 billion to $24.7 billion. Great news, but who will benefit?

CalPERS isn’t saying just yet, but David Fann, president and CEO of PCG Asset Management LLC, a long-time advisor to the CalPERS, believes that major plan sponsors will likely be focusing much of their attention this year on LBO funds, distressed funds, and leveraged loan funds. CalPERS’s efforts to deliver solid risk-adjusted investment returns over the next three years will also hinge on its ability to back those teams identifying the most promising industries. For his part, Fann likes health care, which he calls “extremely interesting to us.” Other appealing industry sectors include cleantech and financial services. “It’s a contrarian play,” said Fann of the latter, but “we think they might be oversold in this environment.”

“Default rates are at an historic low—around 1.5 percent, down from 3 to 4 percent—so we see a lot of potential there in a deteriorating economic environment. And a lot of folks think distressed is an interesting play given the softening economy,” Fann said.

CalPERS may also do more co-investing to avoid rich management fees. “We’re definitely seeing more [co-investing by plan sponsors] because of lower management fees—in some cases as low as zero percent—and it’s a way to get yield enhancement and to participate [in a deal] with a firm you already have a relationship with,” said Fann.

Whether CalPERS will do more or less investing in mega-funds remains to be seen. It recently committed $1 billion to Apollo Management LP’s Apollo Investment Fund VII LP, which is looking to raise nearly $16 billion. But PCG is emphasizing more small and medium-size funds, as well as leveraged loan funds, strategies that could help CalPERS capitalize on the continuing credit vacuum, as well as ensure that the deals to which it is ultimately committing get done. “As a consultant, tactically, we’re just not sure how the large leveraged buyouts [complete their acquisitions] now that the sub-prime [loans] are posing such a serious problem to them,” said Fann.

Venture capital firms will get their fair share of dollars from CalPERS, although Fann himself has concerns about the increasingly high valuations that early to mid-stage companies are commanding. “We’re seeing late-stage [funds] attracting a lot more capital.”

In December, CalPERS also announced it was decreasing its allocation to public stocks, globally, from 60 percent to 56 percent, that its fixed-income investments would drop from 26 percent to 19 percent, and that real estate investments would account for 10 percent of its massive portfolio, up from 2 percent.—C.L.