Skip to main content
MENU
Subscribe
  • Subscribe
  • Account
  • LOGIN
  • Topics
    • Alternatives
    • Consultants
    • Coronavirus
    • Courts
    • Defined Contribution
    • ESG
    • ETFs
    • Hedge Funds
    • Industry Voices
    • Investing
    • Money Management
    • Opinion
    • Partner Content
    • Pension Funds
    • Private Equity
    • Real Estate
    • Russia-Ukraine War
    • SECURE Act 2.0
    • Special Reports
    • White Papers
  • Rankings & Awards
    • 1,000 Largest Retirement Plans
    • Top-Performing Managers
    • Largest Money Managers
    • DC Money Managers
    • DC Record Keepers
    • Largest Hedge Fund Managers
    • World's Largest Retirement Funds
    • Best Places to Work in Money Management
    • Excellence & Innovation Awards
    • WPS Innovation Awards
    • Eddy Awards
  • ETFs
    • Latest ETF News
    • Fund Screener
    • Education Center
    • Equities
    • Fixed Income
    • Commodities
    • Actively Managed
    • Alternatives
    • ESG Rated
  • ESG
    • Latest ESG News
    • The Institutional Investor’s Guide to ESG Investing
    • ESG Sustainability - Gaining Momentum
    • Climate Change: The Inescapable Opportunity
    • Impact Investing
    • 2022 ESG Investing Conference
    • ESG Rated ETFs
  • Defined Contribution
    • Latest DC News
    • DC Money Manager Rankings
    • DC Record Keeper Rankings
    • Innovations in DC
    • Trends in DC: Focus on Retirement Income
    • 2022 Defined Contribution East Conference
    • 2022 DC Investment Lineup Conference
  • Searches & Hires
    • Latest Searches & Hires News
    • Searches & Hires Database
    • RFPs
  • Performance Data
    • P&I Research Center
    • Earnings Tracker
    • Endowment Returns Tracker
    • Corporate Pension Contribution Tracker
    • Pension Fund Returns Tracker
    • Pension Risk Transfer Database
    • Future of Investments Research Series
    • Charts & Infographics
    • Polls
  • Careers
  • Events
    • View All Conferences
    • View All Webinars
    • 2022 Retirement Income Conference
    • 2022 Managing Pension Risk & Liabilities
    • 2022 WorldPensionSummit
Breadcrumb
  1. Home
  2. ALTERNATIVES
December 12, 2016 12:00 AM

CalPERS studies ways to keep private equity afloat

System eyes options to continue performance of strongest asset class

  • Tweet
  • Share
  • Share
  • Email
  • More
    Reprints Print
    Michael Moy thinks the pattern of private equity returns won't hold up to historical norms.

    The California Public Employees' Retirement System is grappling with ways its $26.4 billion private equity program can continue to produce superior results in an era of expected lower returns across asset classes.

    Theodore Eliopoulos, chief investment officer of the nation's largest pension fund, has ordered a review to see what the $299.9 billion fund can do to maintain the returns that made private equity its best producing asset class, with a 10.2% annualized net return over the past decade.

    But Mr. Eliopoulos and CalPERS private equity staff will face headwinds. One way to make up for weaker future returns would be to save on fees paid to private equity general partners — in effect, cutting them out of the equation.

    Mr. Eliopoulos told the system's investment committee Nov. 14 the review will examine a number of possibilities, including direct private equity investments.

    CalPERS paid about $900 million in fees to private equity general partners for the year ended June 30, and outside experts say those fees could be cut significantly if the system ran a direct investment program.

    The review comes at a critical time. CalPERS is already facing diminished return expectations in other asset classes over the next decade. Staff and consultants are considering whether the assumed rate of return should be reduced from the current 7.5%, a move that would trigger increased contributions from government units, adding to their financial pressures. The investment staff and consultants are expected to make a recommendation on reducing the system's return assumption at a meeting Dec. 20.

    One critical problem for the private equity program is the high valuations of companies that are potential targets of buyout funds, CalPERS officials and consultants say. Buyout funds make up 57% of CalPERS private equity portfolio, according to the system.

    The problem is not unique to CalPERS; other institutional investors with private equity programs are facing the same challenges, said Michael Moy, a Mission Viejo, Calif.-based managing director at Pension Consulting Alliance Inc., CalPERS' private equity consultant.

    Higher valuations mean the multiples paid for portfolio companies will be higher — and those multiples will need to expand even further to make a large profit when the company is sold, something that might not be easy to do, said Mr. Moy.

    And while many private equity managers remain disciplined, holding out until the price is right to acquire portfolio companies, that creates another problem, Mr. Moy said — capital can't be put to use.

    Distributions vs. calls

    CalPERS data show gross cash distributions from private equity partners to the pension system of $15.6 billion for the two years ended June 30. During that same period, private equity partners only called $7.4 billion of capital from the pension fund.

    As of June 30, the system had $13.7 billion in commitments that had not yet been called because private equity general partners can't find the right investments at the right price.

    “Return expectations are compressing,” said Mr. Moy. “Maintaining the allocation level is going to be difficult because of the level of distributions that have been occurring and the reduction in the investments that are being made by the managers. What ultimately is going to happen is an unknown, but private equity is not going to be as vibrant in the very near future as it has been historically.”

    The challenges to the asset class are clear. Statistics from London-based alternatives data provider Preqin, show U.S. private equity funds had capital calls of $79.5 billion in the six months through June 30, while making $160.3 billion in cash distributions. In calendar year 2015, capital calls totaled $170.5 billion, while distributed capital was $259.3 billion, Preqin data show.

    For CalPERS, as billions of dollars allocated to private equity remain on the sidelines, the amount of capital deployed in funds is shrinking, and that could mean smaller cash distributions coming back to the system in the future. The $26.4 billion deployed in private equity funds and vehicles as of June 30 is down from the $34.2 billion invested as of June 30, 2012, system statistics show.

    For the fiscal year that began July 1, CalPERS now plans to commit $4 billion, down from an earlier estimate of $6 billion, said CalPERS spokeswoman Megan White in an e-mail. Ms. White said the switch was made because “current valuations and capital overhang in private equity are elevated vs. historical long-term averages.”

    Already reducing

    Mr. Eliopoulos and staff are already in the process of reducing the number of private equity managers the pension fund uses, but focusing on those with top results can also means higher fees. The number of managers had been reduced to 99 as of June 30 from more than 200 in 2015, according to fund statistics. CalPERS cut several dozen managers by selling its interest in funds on the secondary market, officials disclosed at the Nov. 14 meeting.

    Mr. Eliopoulos has said his goal is to get down to 30 private equity managers by 2020, but Mr. Moy said it would be difficult for 30 managers to have the capability to handle the private equity program's net asset value of $26.4 billion.

    Requests to talk with Mr. Eliopoulos or other members of CalPERS investment staff members were declined. Ms. White said they were not available for an interview.

    “We continue to examine alternatives to investments in private markets,” she said in an e-mail. She also stressed the review was in its early days and that “there are many challenges to sort out before we could potentially bring forward a new, more direct approach to investing in private equity.”

    Large public Canadian pension funds have successfully run direct investment programs for more than two decades, reducing expenses by about two-thirds by cutting out external managers, said Keith Ambachtsheer, director emeritus of the Rothman International Center for Pension Management at the University of Toronto.

    Mr. Ambachtsheer said key to running a successful program is paying investment staff attractive salaries of several million dollars each, as the Canadian pension plans do. While that is still below what can be made at private equity firms, he said, there is the incentive of not having to do sales, in addition to investment duties and the satisfaction of working on behalf of public-sector employees.

    “There are a lot of good people who would rather work for half their salary for an organization that has a clear public purpose,” Mr. Ambachtsheer said.

    But CalPERS private equity investment staffers make far less than $2 million a year. An investment manager at CalPERS who supervises portfolio managers makes less than $250,000 annually, according to California state salary guidelines, though they are eligible for a bonus.

    Mr. Ambachtsheer said CalPERS board would not be “doing its fiduciary duty” if it doesn't seriously evaluate running a direct private equity program, noting the cost saving is enormous.

    In one sense, CalPERS has an advantage over other institutions in that it has a private equity program large enough to attract a talented investment staff, he said.

    Considered going direct

    CalPERS has considered running a direct private equity program before. It looked at the issue in 1999 and several times after that, said Michael Flaherman, who served on the CalPERS board from 1995 to 2003, the last three years as chairman of the investment committee.

    Mr. Flaherman, a former private equity firm executive and now a visiting scholar at the Center on Governing & Investing in the Future at the University of California, Berkeley, said one idea floated in the past was forming a separate state corporation to run private equity investments for CalPERS to get around state salary rules.

    “I don't think it is an insurmountable problem,“ he said. “If (CalPERS investment staff and board) go to the Legislature and try to change the law, there is a possibility that they can succeed.”

    Board member J.J. Jelincic thinks CalPERS can eliminate general partners and run its own private equity program without a revision of state law.

    Mr. Jelincic said the real issue is that board members would be afraid of the publicity surrounding the revelation they several dozen staff members are making $2 million a year each. “They don't have the stomach for it,” he said.

    Related Articles
    CalPERS' private equity program size declining despite top performance
    CalSTRS says 85% of management fees in 2015 went to private markets
    CalPERS mulls going direct in private equity
    CalPERS eyes vote to reduce assumed rate of return
    CalPERS slates $270 million for buyout fund
    CalPERS reduces global, private equity allocations, expands tobacco investments…
    CalPERS board gives green light to cut assumed rate of return to 7%
    Fundraising environment obscured by uncertainty
    Second California appeals court rules pension benefits can be reduced
    CalPERS sells 26 private equity fund interests for $426 million
    CalPERS turns to Meketa as private equity consultant after abrupt PCA resignati…
    CalPERS' investment staff proposes structural changes for real assets portfolio
    Canadian plans answer staff dilemma
    Meketa says CalPERS' new private equity structure misses opportunities, produce…
    Recommended for You
    Wafra brings on managing director to lead new co-investment strategy
    QIC adds director of multisector private debt
    David Malpass
    Market volatility could boost commodities
    SPDR® ETF’s New Approach to Bond Liquidity
    Sponsored Content: SPDR® ETF’s New Approach to Bond Liquidity

    Reader Poll

    June 6, 2022
    SEE MORE POLLS >
    Sponsored
    White Papers
    Nearing the finish line: Ideas on end-state investing for corporate DB plans
    The Meaning of "Portfolio Intelligence"
    Credit Indices: Closing the Fixed Income Evolutionary Gap
    Forever in Style: Benchmarking with the Morningstar® Broad Style Indexes℠
    Crossroads: Politics, Inflation, & Bonds
    Is there a mid-cap gap in your DC plan?
    View More
    Sponsored Content
    Partner Content
    The Industrialization of ESG Investment
    For institutional investors, ETFs can make meeting liquidity needs easier
    Gold: the most effective commodity investment
    2021 Investment Outlook | Investing Beyond the Pandemic: A Reset for Portfolios
    Ten ways retirement plan professionals add value to plan sponsors
    Gold: an efficient hedge
    View More
    E-MAIL NEWSLETTERS

    Sign up and get the best of News delivered straight to your email inbox, free of charge. Choose your news – we will deliver.

    Subscribe Today
    June 20, 2022 page one

    Get access to the news, research and analysis of events affecting the retirement and institutional money management businesses from a worldwide network of reporters and editors.

    Subscribe
    Connect With Us
    • RSS
    • Twitter
    • Facebook
    • LinkedIn

    Our Mission

    To consistently deliver news, research and analysis to the executives who manage the flow of funds in the institutional investment market.

    About Us

    Main Office
    685 Third Avenue
    Tenth Floor
    New York, NY 10017-4036

    Chicago Office
    130 E. Randolph St.
    Suite 3200
    Chicago, IL 60601

    Contact Us

    Careers at Crain

    About Pensions & Investments

     

    Advertising
    • Media Kit
    • P&I Content Solutions
    • P&I Careers | Post a Job
    • Reprints & Permissions
    Resources
    • Subscribe
    • Newsletters
    • FAQ
    • P&I Research Center
    • Site map
    • Staff Directory
    Legal
    • Privacy Policy
    • Terms and Conditions
    • Privacy Request
    Pensions & Investments
    Copyright © 1996-2022. Crain Communications, Inc. All Rights Reserved.
    • Topics
      • Alternatives
      • Consultants
      • Coronavirus
      • Courts
      • Defined Contribution
      • ESG
      • ETFs
      • Hedge Funds
      • Industry Voices
      • Investing
      • Money Management
      • Opinion
      • Partner Content
      • Pension Funds
      • Private Equity
      • Real Estate
      • Russia-Ukraine War
      • SECURE Act 2.0
      • Special Reports
      • White Papers
    • Rankings & Awards
      • 1,000 Largest Retirement Plans
      • Top-Performing Managers
      • Largest Money Managers
      • DC Money Managers
      • DC Record Keepers
      • Largest Hedge Fund Managers
      • World's Largest Retirement Funds
      • Best Places to Work in Money Management
      • Excellence & Innovation Awards
      • WPS Innovation Awards
      • Eddy Awards
    • ETFs
      • Latest ETF News
      • Fund Screener
      • Education Center
      • Equities
      • Fixed Income
      • Commodities
      • Actively Managed
      • Alternatives
      • ESG Rated
    • ESG
      • Latest ESG News
      • The Institutional Investor’s Guide to ESG Investing
      • ESG Sustainability - Gaining Momentum
      • Climate Change: The Inescapable Opportunity
      • Impact Investing
      • 2022 ESG Investing Conference
      • ESG Rated ETFs
    • Defined Contribution
      • Latest DC News
      • DC Money Manager Rankings
      • DC Record Keeper Rankings
      • Innovations in DC
      • Trends in DC: Focus on Retirement Income
      • 2022 Defined Contribution East Conference
      • 2022 DC Investment Lineup Conference
    • Searches & Hires
      • Latest Searches & Hires News
      • Searches & Hires Database
      • RFPs
    • Performance Data
      • P&I Research Center
      • Earnings Tracker
      • Endowment Returns Tracker
      • Corporate Pension Contribution Tracker
      • Pension Fund Returns Tracker
      • Pension Risk Transfer Database
      • Future of Investments Research Series
      • Charts & Infographics
      • Polls
    • Careers
    • Events
      • View All Conferences
      • View All Webinars
      • 2022 Retirement Income Conference
      • 2022 Managing Pension Risk & Liabilities
      • 2022 WorldPensionSummit