CalPERS makes $1 billion bet on small funds as new CIO reshapes pension

The California Public Employees' Retirement System is making a $1 billion wager that small private equity firms without the heft of the biggest buyout institutions can boost the pension giant's returns and clout.

CalPERS, the largest public pension fund in the U.S., will invest $500 million each with TPG and GCM Grosvenor to help launch funds backing up-and-coming private equity firms, pension officials said. Those funds could take stakes in smaller investment managers and direct money to those run by women and minorities, as well as offer seed funding to newer firms.

CalPERS Chief Investment Officer Nicole Musicco says CalPERS' latest investments aren't related to affirmative action or politics. Instead, she hopes that by forging ties with private equity managers while they're young, CalPERS will become one of the first calls made when choice deals arise.

"It's not about a diversity play," she said in an interview. "It's about generating alpha in a more thoughtful way and leveraging partners we will work hand in glove with."

Ms. Musicco has made a push for the $449 billion pension fund to invest directly in companies and bypass private equity giants. After joining CalPERS in February 2022, Ms. Musicco began mapping out a strategy that will gradually curb its reliance on the biggest private equity funds and reduce fees over time.

CalPERS is the first major investor in TPG's new Next fund and Grosvenor's new Elevate strategy. The fund could do more strategic partnerships with managers in other investment areas, she said, and it will help "to have a smart friend at the table."

Ms. Musicco, who spent more than 16 years at the Ontario Teachers' Pension Plan, faces the challenge of restoring CalPERS' credibility and influence after it cycled through a series of leaders, strategy shifts and a retreat from private equity in the decade following the financial crisis. At the same time, she has to navigate demands from politicians and other local organizations on how state money should be managed.

California politicians passed a law in 2021 requiring the biggest public pensions to report more details on their investments with "emerging or diverse managers."

Like other pension funds, CalPERS has faced a shortfall — the firm's funded status fell from 81.2% in June 2021 to an estimated 72% a year later. CalPERS posted a 6.1% loss in the latest fiscal year, marking its worst investment performance in more than a decade. Meanwhile, the pension fund's private equity investments had positive returns of 21.3%.

The new CIO has made an effort to give staff more power to invest in private assets without permission from the board. While she says the latest investment doesn't represent a "diversity play," Ms. Musicco has also advocated for the firm to weigh environmental, social and governance concerns across its investments.

She's taking a bolder approach on new managers than predecessors.

Former CalPERS CIO Ted Eliopoulos embarked on a plan to slash the number of managers the fund worked with during his tenure as CIO from 2014 to 2018. After Ben Meng took over, CalPERS scaled back its use of emerging managers in the stock investing business because various firms' returns fell short.

Gatekeepers of pension money — under intense pressure to make pension checks for retirees more secure — typically demand that money managers have scale and a long history of performance that demonstrates they can weather investment cycles.

As a result, pension funds often go with widely known investment managers such as Blackstone.

"There are attractive returns to be generated by focusing on a segment of the investment universe that has less capital going to it," said Jonathan Levin, the president of GCM Grosvenor, referring to newer and more diverse managers.

"The last few years has brought a broader set of investors into the conversation, but there is more work to be done," he added in an interview.

In 2020, CalPERS started laying the groundwork for adding smaller and mid-size managers. Staffers argued that younger, more eager investors would lift returns. Some studied data showing that managers' earlier and smaller funds outperformed later and larger funds. However, the program's direction was uncertain at that time amid employee turnover and leadership shuffles.

Emerging managers now make up about 2% of CalPERS' $50 billion private equity portfolio.

In a November discussion, CalPERS board member Betty Yee cautioned that the pension would have to weigh performance and costs when thinking about diverse and emerging managers.

"I think cost is still going to continue to be an issue. Track record will continue to be an issue," she said. "But that's not to say we don't cultivate talent because I do think there are new opportunities out there for bringing in these managers."