California Public Employees’ Retirement System is focusing on co-investments and separately managed accounts to cut fees in its private equity program, at least for now, de-emphasizing its ambitious plan to build two $10 billion funds with itself as the sole LP.
Private equity director Greg Ruiz provided rare details on the $410 billion pension’s private equity plans at its investment committee meeting Monday. He spoke at length about ways to improve the PE program’s performance – but made no mention of the funds, which have been on ice since gaining board approval last year.
The funds were part of a “four-pillar” strategy in private equity, which also included emerging managers and traditional partnerships, according to a previous presentation, and were commonly referred to as “pillars III and IV.”
The board approved that plan early last year, as Buyouts reported, but the system has said next to nothing about it since. In an interview with Reuters last year, former chief investment officer Ben Meng said CalPERS was taking its time with the ambitious plan.
The plan drew enormous buzz as a seeming attempt by the US’s largest pension fund to follow the so-called “Canadian model,” wherein pension funds operate private equity in-house to avoid the asset class’s costly fees. Ted Eliopoulos, Meng’s predecessor, said in 2018 the funds would operate as separate accounts with CalPERS as the sole LP and would not be directly owned by CalPERS, as Buyouts reported.
“The entire PE strategy is still moving forward, but we have nothing to announce at this time,” CalPERS spokesperson Megan White told Buyouts when asked if the funds were still happening.
Ruiz’s strategy going forward
Ruiz presented a list of “implementation highlights” from fiscal year 2019-20, which included partnerships with existing and new managers, an expansion of capital deployment and a “commenced strategic planning process.”
While private equity has added value to the fund over the last several years, it could do better, he said.
“Without private equity’s contribution to the total fund over the past decades, we would have lower aggregate returns today,” Ruiz said, according to a rush transcript of Monday’s meeting. “I believe, however, there is a second important question we need to ask ourselves, and that is has the CalPERS private equity program performed at or near its potential? I believe the answer to that question is that it has not.”
Ruiz provided four “significant drivers” for why he felt that was the case: a lack of consistent capital deployment, a lack of strategic consistency, a lack of diversification and a lack of cost efficiency. “We understand the reasons for the private equity program’s under-performance, and believe these drivers are reversible over time,” he said.
First was inconsistent capital deployment. CalPERS drastically cut back its private equity commitment pace after the 2008 financial crisis. After committing $14.5 billion in 2007 and $11 billion in 2008, it committed less than $1 billion over the next two years then did not get over $5 billion until 2019, when it committed $6.9 billion, according to documents on its website.
Ruiz also said the fund has cycled through too many PE strategies over time, and would create a “focused” approach involving “deep partnerships with high quality managers, ramping our co-investment program and integrating data into all aspects of our program.”
“We are progressing through a strategic planning process now to clarify our direction for the coming five to 10 years and we’ve already created the focused work,” Ruiz said.
Ruiz provided no details about what this plan was. He did say staff was commencing a “second and final phase” of it.
“We view this as critical to firmly establishing our approach and we look forward to sharing our findings with you,” he said.
As for diversification, Ruiz said the private equity portfolio has not kept up with how the industry has “evolved materially” over the past decade. Its portfolio is heavily concentrated in buyouts, which performs well on a long-term basis, with a relatively small focus on venture or growth equity, which are more focused on technology and which have performed better in recent periods, according to a separate presentation from private equity consultant Meketa Investment Group.
Cost efficiency would come from “scaling” the fund’s co-investment program. The fund’s commitments for the first half of 2020 included co-investments or separately managed accounts with Francisco Partners, which Buyouts covered, Advent International and General Atlantic, among others, according the the fund’s website.
When asked by investment committee chair Theresa Taylor if the more steady investment pace would also help save on fees, Ruiz said it would.
“For us to be a reliable co-investing partner, we need to be consistent with how we deploy our capital, both to funds and to co-investing,” Ruiz said. “Consistency and kind of having a deep partnership approach with our GPs is critical to us securing co-investment over time, which will help us lower the overall cost of the program.”
As of June 30, CalPERS’ co-investments and direct investments totaled $1 billion in net asset value. Its separate accounts totaled $4.5 billion in NAV.
As of September 11, CalPERS total fund market value was just over $410 billion. Its private equity program was valued at $24.6 billion as of June 30. Its program weight is 6.3 percent, below its 8 percent target.
Earlier this year, a consultant’s report said CalPERS’ PE returns in calendar year 2019 were its slowest in a decade, as Buyouts reported.
Action Item: read the total fund investment presentation from the September 14 investment committee meeting here.