Meketa, consultant to CalPERS and CalSTRS, projects lower returns for PE

  • Meketa expects PE to deliver 10-year return of 8.8 pct
  • Declines due to high prices, duration of equity bull run
  • PE historically generated more than 10 pct

Meketa Investment Group expects private equity’s returns to fall below its historic average over the next decade, a recent presentation to Los Angeles County Employees Retirement Association shows.

Meketa, which advises California Public Employees’ Retirement System and California State Teachers’ Retirement System on their $15 billion-plus PE programs, projects private equity to return 8.8 percent over the next 10 years.

The forecast returns fall well short of the 10.3 percent the strategy returned historically, the presentation says. A similar study the firm conducted last year estimated PE would return 9.3 percent between 2017 and 2027.

The declines are likely attributable to the duration of the current bull run in equities, now entering its 10th year, which few — if any — sources expect to continue for another decade.

The presentation pegs global equities at a 6.2 percent return over the next 10 years, 1.5 percentage points short of the the historical average.

Private equity firms often use the share prices of publicly traded companies to assign values to their portfolio companies. As such, declines in the stock market frequently lead to declines in private equity portfolio valuations.

To forecast future returns, Meketa also used information about the amount firms are paying to buy new portfolio companies, along with the level of debt applied to the companies.

Average purchase prices, measured as a multiple of a company’s Ebitda, are at or above historic highs. Leverage levels on new buyouts are also approaching levels not seen since prior to the global financial crisis.

“Higher prices and debt levels have usually been associated with below average results,” Meketa wrote.

Meketa’s PE outlook was included in a presentation recommending changes to LACERA’s asset allocation. The LACERA board voted to change its asset allocation this week, though its private equity target stayed at 10 percent, CIO Jonathan Grabel told Buyouts.

Meketa did not respond to requests for comment.

Meketa isn’t the only group that’s highlighted the possibility of weaker performance moving forward.

Abu Dhabi Investment Authority recently reported it expected PE returns to sag in 2018 and beyond. State of Wisconsin Investment Board’s co-investment team raised the caution flag earlier this year over concerns about rising valuations.

Despite forecasts for lower returns, LPs continue to show confidence in the strategy. A recent Preqin survey found that more than a third of investors plan to increase their commitments to private equity in 2018.

New York State Common Retirement Fund disclosed more than $1.4 billion of commitments during the first quarter. CalSTRS committed almost $7 billion to private equity funds marked as 2017 vintages, doubling its annual allocations to the strategy from 2014 to 2016.

Fund managers have responded to the demand in kind. In a separate Meketa presentation to the CalSTRS board, the firm reported the average fund size is more than double what it was in 2011, according to Preqin data, and median fund sizes grew to $302 million from $200 million.

“My view is that while there’s a ton of dry powder out there, I don’t think it’ll lead to mistakes. The last cycle was painful for the U.S., for the world, for the PE players,” said Eric Schwartzman, a partner in Cooley LLP’s private equity practice. “You’ll see more discipline. You’ll see less debt burden placed on portfolio companies.”