TPG’s Coslet at CalPERS parley: Few companies are truly worthy of long-term holds

A panel of experts offered feedback on California Public Employees’ Retirement System’s plan to create a long-duration captive private equity fund, saying long-term or permanent investments could add value but would have lower returns than traditional PE.

The $346 billion pension system has proposed a new model that would create two CalPERS-controlled PE funds, Horizon and Innovation.

If approved, the Horizon fund would invest long term in large “core economy” companies, while Innovation would focus on late-stage investments in life sciences, healthcare and tech.

Experts invited to speak at CalPERS’s offsite board meeting Jan. 23 gave mixed feedback on the Horizon proposal.

The board, which seated three new members for its first meeting of 2019, heard from TPG CIO Jonathan Coslet, Stanford University Prof. Ashby Monk, and Lindsay Goldberg Partner and former Treasury Secretary Jacob Lew.

All three said permanent-capital funds are still somewhat experimental but could act as a rational supplement to CalPERS’s traditional PE investments.

Investments that can create a permanent income stream, something like 8 percent or 10 percent a year, could be great investments, but they wouldn’t likely grow fast enough to justify a traditional PE-fee structure, Lew said.

“I don’t think these are binary choices,” Lew said. “If you think about the different fee structure that might be associated with that kind of relationship, there probably is a place for it.”

Monk pointed out that a few investors — like Canada Pension Plan Investment Board; GIC, the Singapore government’s investment company; and CDPQ, which manages Quebec’s pension and insurance funds — have made evergreen investments work for them.

Those investors have long-term investment horizons similar to CalPERS, and they figure that long-dated funds can reduce some of the short-term thinking and inefficiency involved in spinning up and winding down PE funds, Monk said.

“That’s the ultimate goal, that we aren’t wasting money and paying bankers and selling from one private equity fund to another…,” Monk said. “Imagine the [carried interest] and banking fees at every layer there. It’s completely inefficient.”

Those asset owners have different governance structures, and CalPERS could mimic them by creating an arms-length structure with a captive GP, as it has proposed with Horizon and Innovation, Monk said.

Coslet said few companies are truly worthy of being owned for 20 years or more, and it’s not always easy to tell which companies will thrive in the face of technological disruption or new competition. Not long ago, Barnes & Noble looked as if it had established itself as a long-term player in the publishing landscape, Coslet said.

“One of the things that gets a little lost in this discussion of long-term investing is there aren’t that many companies that you know when you buy them that you’d like to hold them forever or that you’d like to hold them for 20 years.”

The types of companies that are obvious targets for long-term investing include utilities, which are “lower risk, lower reward, predictable,” Coslet said.

“That’s not a particularly hard-to-understand part of the market, so maybe that’s a good part of the market for someone new to directly managing. But you’re not going to get a lot of alpha out of that,” Coslet said.

“If done right, it’s going to be, this is a utility and I want to lock in the utility, and I don’t want to create the friction cost of having my manager have to resell the utility.”

The shelf life of a typical PE fund also forces GPs to prove themselves by showing off good returns before coming back to market to raise new funds, Coslet said.

Lew said his firm doesn’t have a long-dated vehicle but has debated creating one.

“Candidly it’s something I would love to have because it’s a useful investment vehicle,” Lew said. “I think it’s easier to think through than it is to execute, and I give a lot of credit to the folks here who are thinking about a way to develop that space.”

Monk also said new thinking can help CalPERS thrive in private markets.

“Innovation is critical in alternative markets,” Monk said. “The minute you start doing alternatives in a conventional way, you’re missing the point. You’re going to be paying alternative fees for something that is conventional. … The only way to break out of that is to do something different.”

CalPERS Board Member David Miller said he was more confident of CalPERS’s ability to develop the in-house skills needed to run the Horizon fund than the Innovation fund.

“For us to develop the skillsets to pick things for long-term holds, or pick long-term funds, seems doable to me as a strategic approach,” Miller said.

“But I think we would always need to reach out to partners if we wanted to buy something that could be managed to a higher level of value over a long haul, be it a tech company or a healthcare company.”

Action Item: The slides from Coslet’s private markets presentation to CalPERS are here: https://bit.ly/2SdIH1E