Red Ink Clouds Picture For CalPERS, CalSTRS

It takes a pretty optimistic view to classify the gory performance numbers recently disclosed by California’s massive pension funds as even a mixed bag for buyout professionals.

Although both the California Public Employees’ Retirement System and the California State Teachers’ Retirement System said they would be looking for opportunities to ramp up investment in private equity, among other areas, there was very little in the latest news that could be construed as heartening for general partners.

Perhaps the most provocative development is that CalPERS, the nation’s largest pension fund, indicated that it plans to start pushing back on terms and conditions. One of the planks of its portfolio strategy going forward is: “realigning relationships with hedge fund and private equity partners that can lead to reduced fees, better alignment of interests and more mutually beneficial long-term relationships.”

LPs typically don’t have strong objections to the 2 percent management fee in the standard ‘2 and 20’ fee structure for private equity funds, understanding these monies are needed to cover operating costs and keep compensation competitive. That leaves the 20 percent carried interest rate vulnerable, as well as assorted transaction-related fees. It’ll be interesting to see what headway CalPERS is able to make on this front, if any. The dismal fundraising environment is sure to give the LP some ammunition at the bargaining table but GPs, as always, will be loathe to set precedents.

As for overall performance, CalPERS said the total market value of its assets as of June 30 stood at $180.9 billion, a decline of 23.4 percent from a year earlier. The slide was the most severe single year decline in the LP’s history but CalPERS noted its 20-year investment return was still a positive 7.75 percent. The value of the private equity portfolio, which for both LPs includes the buyout and venture capital strategies as well as pledges to mezzanine pools and funds of funds, dropped an estimated 31.4 percent to $20.6 billion for the 12 months ended March 31. Unfunded commitments totaled $21.9 billion as of April 30.

Meantime, CalSTRS, the second largest pension fund in the United States, said it was temporarily shifting 5 percent of its portfolio away from global equities, splitting the allocation between private equity, fixed income and real estate, in order to be able to buy what it termed “quality assets” from distressed sellers. Whether this means it plans to snap up fund stakes on the secondary market or make new pledges to distressed funds remains to be seen.

On the negative side, the LP disclosed a long-term benefits funding shortfall of $22.5 billion as of June 30, underlining the liquidity challenges it still faces. CalSTRS said the total market value of its private equity portfolio fell 27.6 percent for the 12 months ended March 31 to $14.3 billion. Unfunded commitments to private equity stood at $12.4 billion. The total market value of CalSTRS’s portfolio tumbled 25 percent to $118.8 billion for the year ended June 30.

Aside from the temporary shift in allocation discussed above, CalSTRS outlined other steps it’s taking to reduce its exposure to global equities. These include a permanent shift of 5 percent of its portfolio to a new asset class it’s dubbed ‘Absolute Return,’ which will invest in what it determines are inflation-protected assets, such as infrastructure investments, and other adjustments to its asset mix. There was no word if the LP would invest in infrastructure directly or look for exposure through a fund with that strategy.

Both LPs have slowed their pledge pace since the financial meltdown began in late 2008. CalSTRS made a single private equity pledge in the first quarter, a $65 million commitment to New Enterprise Associates 13 LP, a vintage 2008 venture capital fund managed by Baltimore-based New Enterprise Associates that’s seeking $2.75 billion. In the year preceding March 31, CalSTRS made commitments totaling $3.9 billion. It contributed capital of $4.4 billion in that time and received distributions of $773 million.

For its part, CalPERS hasn’t made a new pledge since it signed off on a $200 million slug for venture capital pool Kholsa Ventures Expansion Fund in December 2008. According to data gleaned from the LP’s investment committee agendas, CalPERS has been subject to capital calls totaling roughly $2.3 billion since October 2008, just after the bankruptcy filing of Lehman Brothers sent the global stock markets into turmoil. It’s seen total distributions of about $435 million over that stretch.

Representatives of CalSTRS didn’t return a request for comment on the results. Clark McKinley, the information officer for CalPERS, offered some general comments about the year’s performance in an e-mail, saying: “Private equity has been a top performer for us over the past 5 years and longer, although we had negative returns over the fiscal year that ended June 30, 2009. We still see this asset class as a sound portfolio diversifier promising returns 3 percent or more above public stocks. Also, private equity is breaking the new ground in terms of new products. Our overall AIM portfolio is relatively young, so we expect increasingly higher returns as funds mature.”