CalPERS Falling Short of Private Equity Goals

The private equity program at the California Public Employees’ Retirement System (CalPERS) is continuing to shrink, shows a new report by Meketa Investment Group, the system’s PE consultant.

Meketa says the largest US pension plan needs to be able to increase PE commitments on a steady basis to meet its 8% target allocation to the asset class. CalPERS staff and Meketa agree that the pension will need to invest at least $10 billion per year into private equity opportunities—a substantial increase over the $6.7 billion (2018-2019), $5.3 billion (2017-2018), and $3.3 billion (2016-2017) in fiscal years prior.

Meketa, in a report to be presented to CalPERS investment committee Monday, notes the reverse is occurring: the private equity allocation at the approximate $380 billion fund is shrinking.

Meketa said at the end of the June 30, 2019, fiscal year, the CalPERS private equity portfolio was $26.5 billion, an approximate 3% decrease over the prior fiscal year’s $27.2 billion.

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“One of the key challenges faced by CalPERS is to deploy capital on a steady basis in order to maintain the desired allocation to the private equity asset class,” said the Meketa report.

CalPERS investment officials have said they can’t find enough suitable private equity investments to build the asset class to the scale they would like. They have acknowledged intense competition among institutional investors to become limited partners in funds run by the most successful private equity general partners.

Meketa said the current private equity exposure is 7.1%, compared to the desired 8%. Just several years ago the program’s size had exceeded 10% of CalPERS’s total portfolio.

Part of the problem, the report notes, is that not all the money being committed is being called by private equity general partners. The pension plan is also seeing new commitments negated by fund redemptions.

“While the program had an overall value increase of over $2 billion, the underlying managers returned substantially more cash (largely from exited investments) than they called for new investments, leading to a net decline in the Program’s NAV,” Meketa said.

Distributions from general partners in the private equity program in the latest fiscal year totaled $7.4 billion outpacing contributions of $4.6 billion, the report said.

The contributions are made up of money called by general partners from commitments made over a period of years, not in one single year.

The private equity consultant said unfunded commitments from CalPERS’s general partners was $18.5 billion at the end of the June 30 fiscal year.

Private equity is CalPERS best-producing asset class, both short-term and long-term.

In the latest June 30 fiscal year, the asset class produced returns of 7.7%. Over the three-, five-, and 0-year periods ending June 30, it produced returns of 12.5%, 9.6%, and 14%, respectively

The asset class’ performance can be seen here:

	NAV ($ mm)	1 Year (%)	3 Year (%)	5 Year (%)	10 Year (%)
Buyouts	18,060	8.2	14.2	11.0	14.3
Credit	1,992	1.8	6.0	2.2	14.8
Growth/Expansion	3,715	5.5	14.8	10.9	14.0
Opportunistic	2,109	13.0	10.6	14.0	13.4
Venture	550	16.9	3.8	3.2	6.7
Other	45
CalPERS PE Program	26,472	7.7	12.5	9.6	14.0
Policy Benchmark		4.0	14.1	10.3	16.6
Excess vs. Policy Benchmark (%)		3.7	-1.6	-0.8	-2.5
FTSE All World + 150 bp (%)		4.4	12.7	8.5	14.1
Excess vs FTSE All World + 150 bp (%)		3.4	-0.2	1.0	-0.1

Source: Meketa Investment Group

CalPERS investment staff has been working on its own direct-style private equity program, which would increase the allocation to PE, but the program is still a work in progress. The pension’s investment committee approved a plan to create two new private equity organizations in March 2019 that would see up to $20 billion in direct investments.

CalPERS Board President Henry Jones said in a separate interview that CalPERS investment staff continues to look for investment partners to run the program but offered no specifics as to whether CalPERS was close to signing a deal.

The pension fund’s investment staff had originally hoped to have the program running by the end of this year.

Meketa did not offer a timetable in its report, only acknowledging the importance of the program to increasing the size of the CalPERS private equity program.

The consultant said investment staff is also continuing to develop a comprehensive plan for sourcing, analyzing, executing, and managing private equity co-investments, with a focus on opportunities sourced from CalPERS’s core managers.

CalPERS private equity co-investment program is around $2 billion. The pension plan stopped making co-investments in 2016, a decision made by its former Chief Investment Officer Ted Eliopoulos. It has never been publicly disclosed why Eliopoulos stopped the investments.

Meketa said CalPERS investment staff also is looking to expand the private equity program beyond its core 30 general partners. “The expansion of the manager set provides opportunity, not only to increase scale, but also pursue strategies beyond the mega and large buyouts in order to add portfolio diversification,” Meketa said.

In May, CalPERS appointed a new chief for its private equity operations. Greg Ruiz was selected after a two-year search, replacing Real Desrochers, who left the fund in 2017 to join Chinese bank CITIC.

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Back in the 1970s, the big fear was a “population explosion”—an expected surge in the world’s populace that seemed to threaten to outstrip its resources, leading to wars and famines. But that dire scenario didn’t happen.

Declining fertility rates and shrinking labor forces are the trends now making the future look perilous. As Joe Quinlan, head of market strategy for Bank of America’s Chief Investment Office, warned in a note to clients, “the growth rate of any economy is dependent on population growth. The larger the population, the greater the labor force, the more capacity for consumption as workers per capita increases, and the deeper the base of taxpayers to support retirees.”

What does that mean for investors? Slower economic growth, low interest rates, and deflationary pressures.

Where does Quinlan suggest that you should channel your investments? To healthcare and technology, specifically robotics, automation, and artificial intelligence. Health stocks because an aging population will need more care, and the tech solutions, as they would take up the slack from an insufficiently large human labor force.

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These alternatives, he wrote, mirror “the new normal of global demographics.”

For a glimpse of the future, Quinlan points to Japan, whose three decades of economic stagnation dovetail with its diminishing population growth. And the same is happening in Europe, he noted.

Citing United Nations statistics, he pointed out that the populations of 55 nations are expected to lose 1% between 2019 and 2050. Studies show that 2.1 children per woman is the number that keeps a population expanding, but the latest US rate dipped to 1.72 last year. In 2018, for the first time in history, the number of people over 65 in the world exceeded those under age 5.

As Quinlan put it, “Babies matter.”

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Tags: Bank of America, fertility rates, Joe Quinlan, population growth