Editor’s Letter: Big moves in California – and readers respond

California Public Employees’ Retirement System has earned a reputation as one of the toughest limited partners in the business.

This is because the system takes a hard line on fees and other terms, pushing back on managers to the point that some GPs don’t look for capital from CalPERS, once the most important LP in the industry.

It’s a cautionary tale: LPs need to be tough on terms and conditions and should push back at GPs, especially in today’s bull-market fundraising environment. But by doing so, by negotiating hard, they risk turning off the top performing GPs who don’t need to deal with tough negotiators. These GPs can turn to LPs who desperately want into their funds — including sovereign funds that can cut huge checks and don’t put up too much of a fight on fees.

But it’s unclear whether CalPERS even cares too much because the system is restructuring its PE program in a way that seems to focus more on direct investing. Over the next few years, the system is consolidating its private equity portfolio to about 30 managers from about 100.

CalPERS is considering rolling its PE program into a broader global equities portfolio. Under this structure, CalPERS would also change the benchmark it uses for private equity. CalPERS’s portfolio would be measured against the FTSE All World, All Capitalization index, the same benchmark as global equity.

CalPERS’s PE moves spurred feedback from readers. Check this out:

James: It should come as no surprise that some (many?) firms choose not to deal with CALPERS, or CALSTRS or New York Common, etc. This has been going on for years. The best firms absolutely don’t need them and have no need to put up with the adversarial positions the big pension funds often take vis a vis their GPs. Spirit of partnership? Hardly. They’re typically hard to deal with, demanding for no reason and have stated publicly that they will do whatever they can to drive fees down (ignoring net returns). My firm has been approached multiple times by gatekeepers for the funds I mentioned above and turned them all down. We are far from alone.

Anonymous: This is part and parcel of a trend by unsophisticated senior leaders at pension plans in confusing private equity — the ultimate active asset strategy in most cases requiring direct oversight of a company through positions on the board, setting strategy, targeting specific operational improvements, and hiring and firing senior management – with passive public equity investing through indices. They are not the same thing at all and the relevant comparison is really on superior net performance, not fees per se.

Private equity is an inefficient asset class (if it can even be called that) with a very wide dispersion of returns between top and bottom quartile funds usually driven by specific manager capabilities. And any investor seeking to replicate that and maintain performance needs to pay for qualified, experienced staff with attributable track records of strong performance in not only making investments but in successfully overseeing companies until an exit. That of course requires increasing staffing expense — including bonus systems that act like carry. If you don’t do that, you will fail. There is no free lunch.