California’s $315 retirement system weighing new approaches to private equity investing
From the Wall Street Journal
The largest public pension fund in the U.S. is studying dramatic changes in how it invests in private equity that would slash payments to Wall Street managers, according to people familiar with the matter.
The internal review is the latest effort by the California Public Employees’ Retirement System to re-evaluate its more expensive bets as it wrestles with a cash crunch, a widening funding deficit and declining estimates of future earnings from stocks and bonds. Calpers—like many pension funds—doesn’t have enough assets on hand to pay for all future obligations.
The options under consideration could give the $315 billion retirement system a greater hand in selecting and managing its investments in private companies, according to these people. Calpers hopes a new approach will reduce costs.
Among the options being considered are: buying a private-equity firm or creating a separate company outside Calpers that would make private-equity wagers. Calpers could also choose to act as the sole investor in more customized accounts with outside managers, these people said.
In perhaps the biggest shift being reviewed, Calpers also may ask its staff members to make private-equity investments directly.
Other groups that compete for the money of endowments and pensions, including hedge funds and certain mutual funds, have posted outflows in recent years. Some have followed up by lowering fees.
But many private-equity firms have drawn outsize demand and gained the upper hand in setting fees, thanks in part to stronger performance than other asset classes.
Private-equity firms typically buy companies using money from pension funds and other investors, hoping to earn more in a later sale or public offering. Most funds require investors to pay up to 2% of assets under management and share as much as 20% of profits. Nearly 85% of Calpers’s private-equity portfolio is held in such traditional funds.
“We are exploring a number of options, and no conclusions have been made,” said spokesman Brad Pacheco. “We plan to discuss the review with our board over the summer.”
It isn’t yet known whether any of these moves would further reduce the fund’s total private-equity portfolio, which amounted to $25.7 billion as of January.
Calpers had actively reduced some of its desired exposure to private equity, recently lowering its target for total private-equity investments to 8% from a prior 10%. Today, the fund has about 8% in private equity down from more than 14% a few years ago.
Even though private equity has outperformed other Calpers assets over a recent two-decade period, no other investment has been so expensive. Private-equity returns were 12.3% in the 20 years ended June 30, 2015, but they would have been 19.3% without fees and costs.
Calpers’s decision will be closely watched in the pension world, where direct private-equity investments are more common among Canadian pensions than those in the U.S. Calpers, which typically acts as a bellwether for smaller funds, already has made other decisions to eliminate all hedge-fund holdings and sever ties with roughly two-thirds of the private-equity firms that handle its money. It oversees retirement assets for 1.8 million active or retired police officers, firefighters and other public employees.
Calpers’s private-equity review, which began in late 2016, is being led by Chief Investment Officer Ted Eliopoulos and investment director John Cole, according to people familiar with the matter. The person who was in charge of the private-equity portfolio, Real Desrochers, left Calpers this month to join an unnamed financial institution overseas. His departure wasn’t related to the review, said people familiar with the matter.
The subject of fees paid to Calpers’s private-equity managers surfaced as a prominent issue after an April 2015 board meeting when a top pension official acknowledged the fund wasn’t able to provide a full accounting of all private-equity costs. Private-equity funds have complicated, and often opaque, fee structures. Calpers sped up efforts to track fees, and the pension fund disclosed later that year that it had paid $3.4 billion in performance fees to private-equity managers since 1990.
Other public pension funds also have disclosed that total costs associated with these investments were as much as 100% higher than they originally reported.
But there are complications involved in moving to a more direct approach. Calpers reviewed the possibility of setting up a direct investment arm for private equity about two decades ago but ultimately abandoned the plan because of concerns that it wouldn’t be able to sufficiently compensate and attract top investment talent, according to people familiar with the matter. Another worry was that Calpers would be competing with the same outside managers that handled its assets, these people said.
Some of the alternative models now under consideration would exist outside the confines of Calpers, increasing flexibility to pay salaries that would attract top private-equity managers. Calpers’s private-equity managers do some limited direct investing but not enough to affect returns substantially, according to a presentation last year by the pension fund’s former private-equity consultant.
Calpers also is studying an increase in the pension fund’s $3 billion investment in customized accounts, where Calpers partners with external managers to create a fund where it acts as the sole investor.
Those involved in the review have reached out to other investors for advice, said a person close to Calpers, including certain retirement systems in Canada, where some funds have a bigger hand in their private-equity acquisitions.
