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Pension Funds

CalSTRS moves closer to allowing staff more freedom in building private equity portfolio

Policy revamp would allow larger secondary and co-investments to increase competitiveness

Christopher Ailman

CalSTRS' investment committee expressed general support Wednesday for a proposed revamp of the system's private equity program to allow for bigger investments in funds, co-investments and purchase of secondary interests.

The revised rules, which are expected to receive investment committee approval by year-end, are designed to allow investment staff more flexibility in building its $16 billion private equity portfolio, facilitating transactions that can be done without investment committee approval.

The changes comes as CalSTRS' investment staff has been wrestling with a shrinking private equity program. High valuations have meant general partners have had a difficult time in finding portfolio companies to buy. CalSTRS has $13 billion in commitments that have not been deployed.

The changes in policy would allow:

  • investment staff to make commitments of up to $750 million in new funds raised by general partners already in the CalSTRS portfolio, up from the current $500 million;
  • commitments to new private equity managers could go up to $400 million, up from the current $200 million;
  • the size of co-investments entered into by investment staff increase to $500 million, up from the current $250 million; and
  • the size of secondary investment purchases would increase to up to $1.5 billion, from the current $100 million.

"The marketplace has changed," said Christopher Ailman, chief investment officer, in an interview. "We want to make changes to remain competitive."

The plan would change the way CalSTRS engages in co-investments, which amount to about 7% of the private equity portfolio. It could be a way to increase private equity investments in the current environment, Mr. Ailman said.

Currently, the $208.7 billion California State Teachers' Retirement System, West Sacramento, only makes co-investments with existing general partners.

Under the plan, CalSTRS would hire a co-investment adviser, most likely a money management firm, to source co-investments from both the pension plan's existing private equity relationships and other firms. The co-investment adviser would put its own capital at risk in the co-investment, which CalSTRS investment staff believes ensures the adviser is finding the best investment for the pension plan.

Margot Wirth, CalSTRS' private equity director, told the investment committee that expanding co-investments would be a benefit to the pension fund because co-investors typically pay reduced management fees and reduced or no carried interest.

The change in policy would come with some potential increased costs for CalSTRS. Ms. Wirth said CalSTRS would be potentially responsible for due diligence costs incurred for co-investment opportunities that did not occur.

Those added costs did not seem to faze investment committee members, who asked for assurances that major transactions would at least be detailed in closed session. Private equity staff members said they would.

Mr. Ailman said in the interview that the new policy would also change how secondary investments are purchased. He said under the current policy, CalSTRS must be a limited partner in a specific private equity fund for it buy a secondary interest from another investor.

Mr. Ailman said the new policy will allow CalSTRS to buy secondary interests in a new fund, or even an entire portfolio, for example, from another institutional investor.