CalPERS eyes big PE boost as exit outlook remains bleak

This week, big news emerged out of California. The nation’s largest public pension system, CalPERS, moved closer to boosting its target to private equity to 17 percent – an increase that would add billions of dollars to the private equity ecosystem that is struggling with slow exit activity and negative cash flows.

This is welcome news to the hordes of private equity GPs either struggling mightily on the fundraising trail or thinking about launching a new vehicle. Liquidity is at a premium as distributions have slowed and LPs are being very selective with new commitments, mostly sticking with their deepest relationships.

Any new flood of capital into the industry could help ease some of the gridlock currently jamming up new funds.

It’s important to keep in mind, however, that CalPERS wants to boost its exposure primarily to make room for co-investing, which the system has leaned into in recent years. In that case, CalPERS’ big push may not be as significant for fundraising GPs.

Anton Orlich, who heads the $483 billion system’s private equity program, said the system’s increased focus on co-investments would add 1 percent per year to the target allocation. CalPERS committed nearly $5 billion to co-investments in the second half of 2023, board documents noted.

According to interim CIO Dan Bienvenue, the system has been committing $15 billion to private equity in recent years, with a significant amount to no-fee co-investments. Bienvenue said the system would retain its $15 billion pace to reach the 17 percent target.

“If we stick to 13 percent, we’ll have to back off how much we allocate. Our primary fund investments will stay the same, but the amount we commit to co-investments will fall off,” Bienvenue said.

Exit channel ‘difficult for most assets’

The CalPERS news comes at a time of a potentially improving deal environment (good news for co-investments) but a still bleak exit outlook (bad news for fundraising).

Exits are likely to remain hamstrung from pressures across the three traditional pathways to liquidity for private equity firms, Hugh MacArthur, global chairman of the private equity practice at Bain & Co, said this week on a webinar about the company’s annual global private equity report. He outlined the challenges facing private equity firms in the higher rate environment, and also listed potential ways GPs can navigate through the tough market.

“This industry is entrepreneurial, innovative and finds solutions to problems,” he said. “It always has and I’m optimistic it’ll continue to navigate these issues in the short run to get back to long-term” outperformance.

Dealmaking is likely to pick up with nearly $4 trillion of dry powder across private markets, over $1.2 trillion for buyouts. Over a quarter of that is at least four years old, “and that means that capital wants to be put to work,” he said.

“That’s enough equity capital that’s been committed to actually do an awful lot of transactions, so we’re pretty bullish on dealmaking for the 2024/2025 time period,” MacArthur said. “Obviously we can’t predict black swan events, but this amount of capital is going to support pricing and also going to support creative ways to get deals done.”

Exits are a different story, however. Public listings are still slow overall, and as an exit for private equity, IPOs are inefficient – they require more scrutiny, are expensive and take several years before the sponsor can take money out of the company. Even before the era of rising rates and inflation, IPOs were not a great option for private equity.

Sponsor-to-sponsor exits are impaired because of more expensive debt. “That’s where we’ve got that 500 basis point change in credit cost really affecting that exit channel,” he said.

“If I am a sponsor and I bought something at say 12x using 5 percent debt, the other sponsor that’s now looking to buy that asset with 10 percent debt can only afford to pay 9 or 9.5x for that asset; the math doesn’t work,” MacArthur said. “The seller doesn’t want to sell at 9.5x because they bought at 12; there’s no way I can make my model work with 10 percent debt and get to 12. And so that exit channel is just very difficult for most assets unless they’re really growing fast and churning out a tremendous amount of EBITDA. It’s really difficult to sell into that channel.”

Strategic buyers are facing the same pressures, along with a potentially less acquisitive outlook as they try to navigate uncertainty and the potential for recession.

GPs have a few other options for liquidity these days, like continuation funds. But with around 28,000 companies held in private equity funds, around half of which have been held for four years or more, liquidity will trickle back to LPs over a course of years, rather than in a short period of time.

Exit paralysis is especially taxing for LPs, who have endured cumulative negative cashflows since 2019, MacArthur said. “It’s hard to commit record levels of capital when you don’t know when that capital is coming back,” he said.