CalPERS board hears more detail on direct investment plan

  • Board approved exploring direct investments last month
  • PE program would continue to invest in funds, emerging managers
  • Major questions around governance, outside board remain

California Public Employees’ Retirement System’s board expressed cautious optimism on the prospects of a new private equity investment model its staff introduced to the public last month.

The plan, CalPERS Direct, would launch two new investment platforms managed by a separate investment team and overseen by an outside board. The first would invest in late-stage technology, life sciences and healthcare companies, while the second would make long-term investments in established companies.

The retirement system would continue to commit to PE funds managed by outside firms. CalPERS also expanded its emerging manager program, which would likely continue to be overseen by an outside fund-of-funds manager, CIO Ted Eliopoulos told the board.

The Board of Administration in May greenlit plans to explore an alternative private equity model. Its June 18 Investment Committee meeting marked the first time the board publicly discussed CalPERS Direct.

“CalPERS needs to substantially add to our current business model and internal resources to reach our objective of a substantial and successful PE program over time,” said Eliopoulos, adding CalPERS Direct “would add significant resources and capabilities that we don’t currently possess.”

As envisioned, CalPERS Direct’s flexibility could create major structural advantages for the $355.2 billion retirement system moving forward, particularly as more investors pile money into PE, Stanford University Global Projects Center Executive Director Ashby Monk told the CalPERS board.

“I’m encouraged that if you can get the governance right, if you can evolve this into a platform that can recruit the right talent, you can succeed,” he said.

According to Monk, who’s previously advised University of California Board of Regents and AustralianSuper, CalPERS is in a unique position to break away from the traditional private equity model, in which general partners dictate investment terms and amass millions of dollars through management fees and expenses.

Monk’s praise for the plan wasn’t totally effusive, however. He said “CalPERS Direct” is something of a misnomer, as the retirement system lacks the resources to set up an investment arm whose costs could be fully internalized.

The retirement system will almost certainly have to hire an outside firm to manage at least some of its investments, similar to what was proposed when CalPERS solicited bids from six firms earlier this year.

“It’s less direct than the name implies,” Monk said. “It looks and feels like we’re removing misaligned links in a chain and adding more [aligned links], which is fine. And the part of the reason I think that’s fine is it’s innovation that’s doable and feasible.”

Monk’s comments resonated with several CalPERS board members. Ramón Rubalcava said he was “convinced” that CalPERS needed to adopt a new model for PE investment. Dana Hollinger and Bill Slaton were similarly bullish on CalPERS Direct, noting that it could better position CalPERS for the long-term.

“I don’t think we have a lot of choice around doing it. I think we’ll be compelled by the marketplace,” Slaton said.

“It’s also about aligning our own investment approach to our true future, which is a long-term owner of companies, property, etc, in a way that will generate value for our members,” said Board President Priya Mathur. “Of course, the devil will be in the details.”

Mathur pointed out that CalPERS still has to hammer out details of how the platforms will be governed, including how a separate board would manage bad investments or negative headlines.

Board Members Margaret Brown and State Controller Betty Yee expressed skepticism about whether CalPERS Direct would bring down costs or effectively align itself with the Board of Administration.

To that point, Monk said CalPERS Direct’s feasibility will depend entirely on how its governed. If the Board of Administration exerts too much control, it will likely spook the market, he said. The board will have to obtain a level of comfort with holding the platform at arm’s length and believe in its long-term success while recognizing that mistakes are inevitable.

“You don’t want to short-change your governance conversations; laying the foundation to have the best governance framework is worth every moment you spend on it,” Monk said.

“At that point, don’t let great be the enemy of good. Move fast. Get things built. Recognize that things will be a little messy.”

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