A consultant’s review of the California Public Employees’ Retirement System’s $27.6 billion private equity portfolio has found that the current investment pace is not likely to be sufficient to maintain the pension system’s 8% target to the asset class.

The $361.1 billion CalPERS is below the 8% allocation right now; 7.7% of its portfolio is invested in private equity as of August 31. CalPERS is the largest private equity investor in the US.

The review by the Meketa Investment Group, scheduled to be presented at the CalPERS Investment Committee meeting on November 13, says CalPERS made $5.3 billion of commitments during the 12-month fiscal year ending June 30, slightly below its $6 billion target.

However, the problem goes beyond a $700 million shortfall for CalPERS to reach its target allocation. The pension plan so far has not been able to reach its private equity allocation because it is receiving more distributions as funds end than it can reinvest. Private equity funds normally end after a seven- to 10-year cycle and redistribute profits.

The problem for CalPERS is it can’t find enough new private equity investments in any given year, as Meketa notes. Distributions have exceeded contributions for eight years in a row, including the latest fiscal year, the review noted.

In the June 30 fiscal year, Meketa found that cash distributions to CalPERS from private equity funds  totaled $7.4 billion compared to $4.5 billion in new contributions. While CalPERS made a larger $5.3 billion in new commitments to private equity, not all the money was called by private equity general partners because they did not find suitable investments.

Meketa found that CalPERS’s commitments on a calendar year basis have dropped dramatically since 2008, when the pension system allocated more than $14 billion to new private equity funds. Since then, CalPERS has not allocated more than $4 billion in any single calendar year to the asset class, the consultant’s review shows.

CalPERS’s own data shows that the pension system has received more than $80 billion in private equity distributions combined for the 11 fiscal years between June 30, 2007, and June 30, 2018, but commitments to new investments in that time period are less than half of that figure.

CalPERS’s own investment staff has concluded that the retirement plan would need to make $10 billion in commitments each year for the pension plan to maintain its 8% allocation to private equity, the Meketa review notes.

Pension system investment officials have not detailed extensively in public how they plan to get up to that $10 billion number in their top-returning asset class. They have described an environment at investment committee meetings that pits CalPERS against other institutional investors, as they vie to be part of over-subscribed top-tier private equity funds.

What’s clear is the importance of the asset class to overall returns.

The private equity asset class provided CalPERS with a 16.1% net return in the fiscal year ending June 30, 9% over the 10-year period, and 10.5% over the 20-year period, shows CalPERS data.

In contrast, the CalPERS overall fund produced an 8.6% return in the latest fiscal year, a 5.6% return for the 10-year period, and a 6.1% return for the 20-year period. CalPERS is only 71% funded.

While it stills needs final board approval, the $13 billion private equity direct investment organization CalPERS has announced it plans to build that would invest in later-stage companies in the venture capital cycle as well as make buy and hold investments in established companies is still moving forward. CalPERS officials hope to launch the direct private equity organization in the next several months.

Even with the new direct investment organization, CalPERS official say they plan to keep the traditional $27.6 billion private equity program. The program consists almost exclusively of funds run by general partners, more than 60% buyout funds. CalPERS, along with other institutional investors, is a limited investor in the funds.

Meketa did note that CalPERS’s private equity investment staff has explored a number of alternatives to build up the traditional private equity program. These include separate accounts with key private equity managers to increase deal flow, co-investments alongside existing private equity fund investments, and working with the pension plan’s global equity team to explore investments in publicly traded opportunities that provide private equity-like exposure.

It’s not clear when the talk will move into action.

“We note that Staff completed only one Separate Managed Account in the most recent fiscal year, and has not pursued co-investments, both logical investment strategies for a plan like CalPERS,” Meketa consultants Steve Hartt and Hannah Schriner said in their review. “We understand the execution of these strategies remains under consideration and will likely be revisited once a permanent Managing Investment Director is named.”

Réal Desrochers, managing investment director of the CalPERS Private Equity program, left the retirement plan in April 2017 to take a position with a private equity firm.

CalPERS Chief Investment Officer Ted Eliopoulos, who is departing at the end of the year, said a new private equity head should be named shortly after the new CIO, Ben Meng, takes office.

A start date has not yet been announced for Meng.

Tags: Ben Meng, CalPERS, Meketa, Pension, Private Equity