- Two new vehicles would not be subject to same transparency rules as CalPERS
- Expects long-term Horizon fund to earn lower returns than traditional PE
- Would not fully commit to being sole LP in new funds, leaving door open for partnerships
California Public Employees’ Retirement System’s two new proposed private equity vehicles would need to be less transparent than the rest of the pension system to be able to properly make private investments, according to investment staff at the system’s December meeting.
General Counsel Matthew Jacobs said at the CalPERS board meeting this month that too much transparency “would defeat the entire purpose of the endeavor.”
CalPERS Investment Officer John Cole said at the meeting that “private investing means private.”
In response to board questions, Cole said the new investment vehicles would be exempt from public-records and public-meeting requirements.
“Among the risks that we face is that we create a structure that is doomed to fail, that cannot actually operate in the private market,” Cole said. “An attempt to take private investing and make it public runs the risk of undercutting its very purpose and taking oxygen away from its ability to compete.”
Matthews and Cole were talking about public transparency. CalPERS staff, on the other hand, would need access to detailed information about portfolio companies, Board Member Margaret Brown proposed at the meeting. Staff members agreed with that assertion, saying that CalPERS would get at least as much information from the new funds as it gets from its current GPs.
The $340 billion retirement system has been grappling with how to keep its PE allocation near its 10 percent target.
CalPERS has proposed to reorganize its PE portfolio around four pillars: traditional GP relationships, a focus on emerging managers, and two direct investment vehicles that would target health and technology innovation and on long-duration investments in large businesses.
The system is still working out several key details for the new funds, including ownership, key persons in management and on advisory boards, compensation framework and first-year operating budgets. Cole gave more details about the program at the December meeting.
CalPERS staff also dropped the word “direct” from its discussion of the new Horizon and Innovation funds. The word did not appear in CalPERS’s latest presentations on the PE business plan, and Cole walked back CalPERS’s previous use of the phrase in his discussion of the plan.
Cole explained that the relationship with the new funds would be more “direct” because CalPERS can design the new funds from the ground up, choosing the investment managers and guiding their strategy, and have the new funds work solely on CalPERS’s behalf.
Pressed later about whether CalPERS would remain the sole investor in the new funds, however, Cole would not fully commit to the idea, saying the pension fund wanted the option to partner with other large LPs.
Some board members seemed taken aback by CalPERS’s return assumptions for the long-term Horizon fund, which likely would not match traditional PE returns, Cole said.
He expected higher returns from the Innovation fund, though he did say those returns may be more volatile.
Overall, Cole said he expected the PE plan to beat both public markets and CalPERS’s 7 percent assumed rate of investment return.
CalPERS expects to supplement those returns with savings on fees. The investment vehicles would carry up-front costs but should break even once CalPERS allocates $5 billion to the new funds.
CalPERS also hopes to reduce carried interest by using a netted or pooled model that takes losses into account instead of simply paying carry on one-off transactions that perform well. CalPERS also expects to reduce carry for the new vehicles below the traditional 20 percent, Cole said.
Cole said it would likely take six to 18 months between approval of the new funds and getting the first deal done.
The board has not yet approved the restructuring. CalPERS plans to commission a third-party report on the new structures, including governance and fees, and get an opinion from private equity consultant Meketa before asking for board approval.
Correction: A prior version of this story incorrectly stated that Wilshire, CalPERS’ general investment consultant, would provide a report on the new Horizon and Innovation funds before CalPERS sought board approval. That report will be prepared by Meketa, CalPERS’ private equity consultant. The story has been updated.
Action Item: Read CalPERS staff’s latest presentation to the board on its PE business model: https://bit.ly/2QIiMz6