California Public Employees’ Retirement System (CalPERS) Chief Investment Officer Ben Meng says he is hoping to present a plan to the system’s investment committee next month to restart its private equity co-investment program.

Meng’s comment comes after the CIO disclosed that CalPERS, the largest US pension plan with $354.2 billion in assets, stopped making new co-investments in 2016, even as investment returns were increasing.

For the three-year period ending Dec. 31, the CalPERS $2.3 billion co-investment program saw returns of 17.3% compared to the entire $27.4 billion private equity program’s returns of 12.3%, show pension plan statistics.

Meng made his comments at the system’s May 13 investment committee meeting. Meng hopes to present the new plan on June 17.

Co-investments allow institutional investors to make an investment into a target company, alongside a private equity fund. So normally, CalPERS would be one of the limited partners in a private equity fund, which then buys portfolio companies. The private equity fund manager or general partner would allow CalPERS to buy an additional stake in one or several of the portfolio companies as part of the co-investment.

As Meng explained at the May 13 meeting, co-investments can be attractive to pension plans. He said unlike investments in traditional private equity funds, the private equity general partner in co-investments usually waives the 1.5% to 2% management fee and the 20% split of the profits, known as the carry.

Just exactly why new co-investments, which make up $2.3 billion or about 5% of the system’s private equity portfolio, stopped remains a mystery.

Meng only started in January, so he was not involved in the original decision. There was never a public announcement that new co-investments had stopped in 2016. The CalPERS official who directed all investments, former CIO Ted Eliopoulos, left the pension system last fall for a job at Morgan Stanley in New York

Efforts to reach Eliopoulos were unsuccessful.

Meng fielded questions from investment committee members at the May 13 meeting as to why co-investments had stopped. His response was vague, saying that an on-going review of the private equity program was begun by investment staff in 2016 and it was “prudent to stop the co-investment program as part of the overall review.”

In several back-and-forth exchanges with Meng, investment committee member Margaret Brown pressed for details about the abandonment of the co-investment program, saying there should have been documents or a memo explaining why the program was stopped.

“I just think it’s a shame that we abandoned something that was working for us in 2016…but maybe we can get right back to where we were and keep on growing,” Brown said.

Meng responded that hindsight is 20/20.

“In investments, it’s very difficult and dangerous to look at things in hindsight,” he said.

At the May meeting, Meng told the investment committee that CalPERS made its first private equity co-investment in 1993, but had an inconsistent approach, investing some years in co-investment vehicles, while skipping co-investments in other years altogether.

Meng said the scattered approach led to inconsistent results. This changed, he said, in 2010, when CalPERS began to make co-investments every year and started to see better results. CalPERS policy changed again when it suspended the co-investment program in 2016, he said.

He told the investment committee that the new co-investment program must have a steady deployment of money each year, irrespective of market cycles. Meng said credibility with investment partners will be enhanced by a quick and consistent approval process for co-investments.

Meng didn’t go into detail, but CalPERS investment officials have said in the past that the bureaucratic nature of the approval process at the pension plan can mean delays of weeks or more in approving investments.

Avoiding those delays could be important to getting into the top co-investment deals. Meng said back at the April investment committee meeting that demand from institutional investors is bigger than supply. Statistics he presented from Cambridge Associates show that in 2018, 72% of large investors had an active co-investment program, making CalPERS an exception among major institutional investors.

One CalPERS insider, who asked not to be identified because he is not authorized to talk on the situation, said the halting of the co-investment program in 2016 occurred at the time that Eliopoulos was in the process of reducing the number of overall external managers and funds that were part of CalPERS’s investment lineup.  Adding co-investments was contrary to Eliopoulos’ plan to shrink the fund’s managers, even if the existing co-investments were having strong returns, he said.

CalPERS spokeswoman Megan White in an email to CIO said she could not comment beyond what Meng had said on the ending of new co-investments.  
The CalPERS insider said the departure of Real Desrochers, CalPERS’s private equity chief, in April 2017, also left the private equity program without a leader to intervene and counter the decision to stop co-investments.  

CalPERS is just now getting a new private equity chief two years after Desrochers’ departure. Meng announced at the May 13 meeting that a veteran private equity industry official, Greg Ruiz, has been hired. However, Ruiz won’t start until July.

Meanwhile, the review of that private equity program continues. The CalPERS investment committee has already given preliminary approval to the pension system building a new direct investment-style private equity program.

The new program could add an additional $20 billion in investments to the CalPERS private equity program. Formal approval of the program could come from the investment committee in the next several months.

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Tags: Ben Meng, CalPERS, Pension, Private Equity, Ted Eliopoulos