CalPERS faces new year full of tough questions

This month, California Public Employees’ Retirement System has been interviewing potential new chief investment officers, according to documents on its website.

The $439 billion pension is trying to move on from a wild, chaotic year, one that leaves big questions about the future of its troubled and erratic private equity program, and whether there is any possible resolution for ongoing conflicts between factions of its stakeholders, staff and board.

The year did not start out with good news: in March, a consultant’s report called the private equity returns for 2019 the slowest in a decade, as Buyouts reported.

The big private equity headline of the year, though, was the sudden resignation of former chief investment officer Yu “Ben” Meng in August after less than two years on the job. The resignation came just days after media reports revealed Meng owned public stock in Blackstone, the Carlyle Group and Ares Management.

The problem: not only had Meng been championing for months the importance of the system upping its private equity allocation, he had personally approved a $1 billion commitment to Blackstone’s latest long-hold fund. His own stock holdings were not large, but nevertheless appeared to constitute a conflict of interest.

Meng resigned effective immediately on August 5, citing health concerns. Thus far, there is no public evidence to indicate he did anything wrong, but he remains under investigation by a California regulatory body.

In statements after the resignation, board president Henry Jones said staff had already known about Meng’s activities, apparently for months, which angered several board members, including State Controller Betty Yee and elected member Margaret Brown.

Yee released a blistering statement criticizing Meng’s “lapse in both judgment and adherence to standard conflict-of-interest policies.” Brown told Buyouts she wanted to see a pause on all private equity investment activity until there was a full investigation, though no other board members joined her.

The fallout was intense and fast. Brown and fellow board member Theresa Taylor, the chair of the investment committee, got into an argument on social media, as Buyouts reported.

At the next meeting, the board returned the investment committee to being a committee of the whole. It also entertained some possible changes to CalPERS rules, including requiring the full board to be notified once an investigation begins into an employee, which did not happen with Meng, and requiring the CEO to share his or her responsibility for overseeing the CIO’s work.

At the same time, the latter part of 2020 did bring a bit more clarity about how the CalPERS private equity program got where it is and how it might get back on track. Its 2019 private equity returns were dismal, even before the covid crisis, and there has been very little information regarding the ambitious plan to create two private equity funds with CalPERS as the sole LP, known as “pillars III and IV.”

More clarity on private equity, but still questions

In September, PE head Greg Ruiz finally gave some insight into where CalPERS might be going. Notably, he did not mention pillars III and IV. He said the CalPERS PE program has suffered from an inconsistent capital deployment, inconsistent strategy, a lack of diversification and a lack of cost efficiency. For now, the plan is to focus on separate accounts and co-investments to alleviate these issues. CalPERS staff did seem to indicate to Buyouts that the pillars strategy may still be in the works, though.

CalPERS definitely seemed to up its commitment pace this year, writing some big checks to big managers. As of September, its PE program was still underweight, though, taking up 6.3 percent of its assets against an 8 percent target.

Some of the policy decisions during Meng’s tenure were also controversial. In June, he unveiled a plan to leverage up to 20 percent of the fund to invest in private equity and private credit, which had a lot of stakeholders, including the city government of Pasadena, deeply concerned. CalPERS also sponsored a bill in the California legislature that would allow it to keep private some information about its private debt program. That got pulled soon after Meng resigned, but recently got resurrected.

An uncertain future

According to the Wall Street Journal, Meng was the sixth CalPERS CIO in the last 20 years. (In comparison, California State Teachers’ Retirement System CIO Christopher Ailman has been at his post since 2000). The lack of continuity in the position likely has contributed to the system’s lack of consistency around private equity.

In recent years, CalPERS also went through the placement agent scandal, which resulted in one former board member committing suicide and a former CEO going to prison.

On top of all of it, the pension is underfunded, only able to cover about 70 percent of its coming liabilities.

One major thing to watch out for will be what the California state investigation finds about Meng’s behavior, and whether that leads to larger repercussions. Another is who the new CIO is and how he or she executes their duties.

And of course what direction the system will go when it comes to private equity. The past few years have brought many plans, but not much has come to fruition. What will the future hold for the system that once was the most important LP in the industry?