- Questions about fees, governance are likely stumbling blocks for board
- Board Member Margaret Brown: “It just doesn’t make sense”
- AlpInvest, BlackRock among firms in running for the outside partnerhips
California Public Employees’ Retirement System might hire an outside firm to manage its $27 billion private equity program.
Then again, it might not.
Multiple sources with direct knowledge of the 13-member board said the proposed hiring of an outside partner to manage its private equity program is far from a done deal. Questions about the cost of the proposed partnership and how it would be governed will likely dominate board discussions as it considers proposals over the coming months.
“There were so many unanswered questions that board members had,” said one source who requested anonymity to speak more frankly. “The board needs to get their arms around what all of the particulars would be.”
Hiring an outside partner to manage its PE portfolio is uncharted territory for an institution of CalPERS’s size. The retirement system’s total assets exceeded $360 billion as of Jan. 31.
Private equity is a long-term asset class and investments made by an outside partner may not yield returns for five or 10 years, further complicating the board’s calculus.
“To me, it’s a hypothesis right now, a theory. [Its effectiveness] can’t be proven or disproven for another decade, and that’s a pretty big risk,” said Margaret Brown, who was elected to one of the board’s 13 seats last year. “Looking at the economics, it doesn’t make sense.”
There’s also the matter of PE’s opaque and costly fees and expenses, a very real and politically charged bugaboo for many members of the board.
CalPERS already pays management fees and expenses to the managers of the private equity funds in the portfolio. Hiring an outside partner to handle new commitments would ostensibly add another layer of fees to the equation, possibly driving up the investment costs of a public pension that was only 68 percent funded as of mid-2017.
“Every single board member is concerned about our funded status,” Brown said. “I think if the board is taking its fiduciary role seriously, which I think they all will, staff will have to prove to us how making this change will improve our funded status.”
Brown’s comments underscore a number of questions and concerns board members will likely raise as CalPERS staff, led by CIO Ted Eliopoulos, review and possibly recommend proposals to hand over control of CalPERS’s private equity program to an outside firm.
A separate source, also with direct knowledge of the board’s discussions, cautioned that the approval of an outside partnership to manage the PE program moving forward couldn’t come without the approval of a strong majority.
“This is not a 7-6 split,” the separate source said.
The CalPERS board is known for its activism, both in regard to fighting fees and on environmental, social and governance matters. To obtain that majority, some board members, including elected officials like State Treasurer John Chiang, would have to become comfortable yielding investment decisions to an outside firm.
In broad strokes, CalPERS is weighing proposals to grant an outside firm discretion over new investments made through its private equity platform (excluding its emerging and transition programs), according to a copy of its request for information.
The legal structure of the partnership remains a question mark, though CalPERS expects the partner to work in close collaboration with its staff to prepare investment plans and allocation strategies.
AlpInvest Partners, BlackRock, Goldman Sachs, Hamilton Lane, HarbourVest Partners and Neuberger Berman submitted proposals for the partnership, Buyouts reported in January. The firms were expected to outline how they would deploy as much as $10 billion of the retirement system’s capital annually, in addition to proposed terms and compensation.
It’s unclear whether hiring an outside partner would help or hinder CalPERS’s attractiveness as a limited partner.
While the retirement system continues to deepen its ties to blue-chip private equity firms like Blackstone Group and CVC Capital Partners, board members and staff members have frequently commented that the system’s requirements grew too cumbersome for some general partners.
According to former board member JJ Jelincic, whose eight-year tenure on the board ended earlier this year, CalPERS CEO Marcie Frost told him that some PE firms intimated they wouldn’t welcome new commitments if the retirement system were directing them from a third party like BlackRock.
Frost and CalPERS declined to comment on Jelincic’s recollection of the conversation.
“We’re continuing the review of our Private Equity program and working with the CalPERS Board to decide any appropriate next steps,” spokesman Wayne Davissaid in an email.
The review and possible site visits with each of the six firms will likely proceed over the next two months, according to the RFI. CalPERS’s investment committee is expected to interview some of or all the firms in March or April.
Materials from a closed session of the board’s Nov. 13 meeting indicate the retirement system originally planned to implement the new partnership “as close to the new fiscal year (July 1, 2018) as possible.” There’s a possibility, however, that CalPERS maintains the status quo and leaves its PE program in the hands of its internal staff, according to the RFI.
“There’s a fair amount of skepticism,” said Jelincic. “But in eight years I can’t remember ever turning the staff down.”
Action Item: For more on CalPERS, visit www.calpers.ca.gov