The largest U.S. pension is making its biggest push ever into private investing, with plans to pour as much as $13 billion a year into non-public companies.
Hoping to outdo stock and bond returns, the $349 billion Calpers on Thursday is unveiling two new in-house strategies that will directly buy stakes in companies — a bid to boost returns by circumventing fees paid to traditional private equity managers. The fund expects “muted returns” of only about 6% over the next 10 years, missing its long-term target, Chief Investment Officer Ted Eliopoulos said.
One new strategy will focus on long-term ownership of income-producing companies, not unlike Warren Buffett’s buy-and-hold style. The other will seek out late-stage technology startups, similar to a venture capital fund. Calpers plans to more than double its annual spending on private investments, convinced public markets alone won’t meet its 7% return target and established private equity firms can’t fulfill all its needs.
“Putting that kind of money to work to keep our allocation at 8% to 10% of the portfolio through traditional models is not possible,” CEO Marcie Frost said in an interview this week in Sacramento. “So we have to look at the way we’re investing in private equity.”
BLACKROCK, GOLDMAN
The new strategies will supplement existing partnerships with managers such as Blackstone, Carlyle and KKR that already handle about $27 billion for Calpers. The pension, which has $14 billion in so-called dry powder awaiting private equity placement, is also reviewing a proposal to hire a partner — BlackRock and Goldman Sachs are among six candidates — to oversee co-investments, separately managed accounts and other strategies beyond traditional funds.
“We know we will need to build a portfolio of scale — a $40, $50, $60 billion private equity portfolio,” Eliopoulos said. “We don’t think we can invest at the scale we need to in the traditional offerings of private equity general partnerships. We need a number of tools in our kit.”
Private assets account for a growing share of the investment universe as fewer companies go public and startups stay unlisted longer. Private equity and venture capital assets under management swelled to a record $2.83 trillion globally as of last June, according to researcher Preqin. Last year also set a record for fundraising at $453 billion.
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Institutions such as pensions, sovereign wealth funds and endowments are exploring options outside traditional private equity models that lock up money for as long as 10 years while charging fees of about 1.5% of committed capital and 20% of investment profits. They also worry that returns may fall as the cost of buyouts rises and the economic cycle meets an eventual downturn.
FEE ‘CONCERN'
“There’s a lot of concern that any fee that we’re paying is not going to a member’s benefit,” Frost said.
In 2014, Calpers was among the first institutional investors to decide to phase out its hedge fund allocation, citing high fees and the complexity of the investments.
Margaret Brown, a Calpers board member, said she’s not ready to sign off on the new strategies yet.
“The board cannot discharge its fiduciary duty with respect to restructuring any part of its $40 billion private equity portfolio without first receiving detailed, written budgets, business plans, and analysis of risks and materials supporting claimed projected returns,” she said in a statement Thursday. “I, for one, intend to see that the board discharges its fiduciary duty.”
The average annualized return of the top 20 funds has been nearly 15%.
The new strategies carry risk. Late-stage startups such as Uber Technologies can run into sudden trouble and few, if any, investors can match Buffett’s record as an acquirer of companies.
While the new strategies offer promise of bigger scale and lower fees, there are also challenges, according to Steven Hartt, principal at Meketa Investment, Calpers’ private equity consultant.
“They need to think carefully about how they set up these investment vehicles,” Hartt said. “If the structure’s not right, there could be a misalignment of interests, and ultimately if this doesn’t go well and Calpers decides to move away from it after getting started, there could be some reputational risks as well.”
For Calpers, private equity has been the best-performing asset class over the past 20 years, averaging 10.8% annual returns. Calpers, which only has about 70% of the funding needed for its long-term liabilities, expects its private equity portfolio to beat stocks by roughly three percentage points a year, according to Frost.
The pension calls its two approaches: Horizon for long-term investments and Innovation for startups. The Horizon strategy will target consumer and industrial companies, especially family-owned firms seeking to stay private, a vast pool of potential investments needing long-term capital, according to Eliopoulos.
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The Innovation fund will invest in “late-stage and early growth” startups, Eliopoulos said in an earlier interview. Previously, the pension giant’s access to young companies has been limited, either because the stakes were too small to move the needle or venture partners balked at transparency and reporting requirements. Massive startups like Airbnb and WeWork have opened fresh opportunities.
‘MISSED OUT’
“We’ve missed out over the last few decades on this enormous generation of returns out of Silicon Valley,” Eliopoulos said. “There’s an opportunity for Calpers to step in to these late-stage ventures and be able to help these companies grow for longer periods of time in the private market.”
For both strategies, he said, Calpers plans to deploy cash through outside managers with “deep domain knowledge” in health care, biotechnology, software and other industries — the type of talent that can be hard for a public agency to hire and compensate internally. Calpers already has similar ties with partners in real estate and infrastructure, directly investing through specialists in apartment, warehouse and renewable-energy projects.
The private equity initiatives are being launched as Calpers undergoes a change in management.
Eliopoulos is leaving at the end of 2018, he announced on May 14 — the first day on the job for his top deputy, Elisabeth Bourqui. Calpers is interviewing candidates in the next two weeks to oversee private equity investments, but must take a patient approach when putting its money to work that doesn’t depend on any one individual, Frost said.
“There’s a lot of talent in the investment office,” she said. “In order to implement some of these strategies, we’re talking five to 10 years to realize the potential return.”
