CalPERS Ends California Initiative

The nation’s largest retirement plan, the California Public Employees’ Retirement System (CalPERS), is winding down its targeted private equity investments programs largely directed at underserved areas in California.

The $355 billion retirement system is ending the California Initative, a 17-year effort to use private equity funds to invest in companies in underserved communities, and is also wrapping up a money-losing fund to invest in California companies using clean technology. It is also concluding that its strategy to invest in the mezzanine debt of California companies isn’t viable long-term.

The largest phaseout is the California Initiative, which has given more than $1 billion since 2001 to private equity firms. The firms then made investments in companies located in areas that had traditionally been bypassed from infusions of institutional equity capital.

The effort did create jobs.

A California Initative report released at the CalPERS Investment Committee meeting on June 18 shows that private equity investments in portfolio companies in those areas created more than 42,000 new jobs since 2001. California accounted for 16,000 of those jobs. The aim of the so-called California Initative was to invest in California, but investments in underserved areas in other states were also allowed.

The problem, according to CalPERS officials, is that the job creation was supposed to be an ancillary benefit of the effort. Strong risk-adjusted investment results, the primary benefit for CalPERS to meet its fiduciary duty, never materialized, Ted Eliopoulos, the retirement system’s chief Investment officer, said.

The second program, CalPERS’s private equity investments in California companies using clean technology, began in 2007 with the start of the $465 million Clean Energy & Technology Fund, managed by Pacific Corporate Group. After poor performance, CalPERS officials severed ties with the group in 2010, but a new manager, Capital Dynamics, has been unable to change the return profile. CalPERS released its most recent data on September 30, 2017, indicating an internal rate of return of -9.7% overall since the fund’s inception.

It’s unclear when the fund will end, as private equity funds normally have a life cycle of seven to 10 years. Clinton Stevenson, CalPERS’s director of investment management engagement programs, said at the June 18 meeting that there will be no follow-on investments for a California-focused clean energy effort. He did not explain why the CalPERS green energy program went sour.

A third in-state private equity effort, a mezzanine debt fund started in 2014, was part of an effort to revive the California Initiative. CalPERS committed an initial $80 million to buying the mezzanine debt of California companies. The debt is considered the riskiest form of debt financing, but can pay returns up to 20%, potentially making it an attractive return for the pension system.

Unfortunately for CalPERS, the returns haven’t been there;  the fund had a -1.6% internal rate of return, as of September 30, 2017.

CalPERS officials had high hopes for the fund, which is managed by Grosvenor Capital Management.

“It’s great to have a hand in stimulating job creation and economic growth in our home state as we seek the best risk-adjusted returns for the portfolio,” Eliopoulos said in a press release in November 2014 announcing the start of the fund.

CalPERS officials did not discuss why the fund has had poor performance at the June 18 meeting, but Stevenson told the Investment Committee that the strategy was not scalable.

“So, we won’t pursue that going forward,” he said. Stevenson did not state what would happen to the current fund.

Eliopoulos also said at the Investment Committee meeting that CalPERS was moving away from smaller initiatives not only in private equity, but across all asset class.

The biggest part of the California Initative was the effort at proving funding for companies in underserved areas. CalPERS gave more than $1 billion to more than four dozen private equity firms who made investments in more than 550 portfolio companies in underserved areas.

Eliopoulos told the CalPERS Investment Committee that the private equity firms overall didn’t perform as CalPERS had hoped.

It’s unclear why the performance of most private equty managers was disappointing and Eliopoulos wasn’t available for an interview. But he stated at the Investment Committee meeting that investing in private equity is risky.

“I just wanted to underscore this is a domain of quite a bit of risk, active risk to the program and huge variability between managers and huge variability between each individual (portfolio company),” he told the Investment Committee.  “That’s the domain for private equity as a whole, not in terms of California versus New York or undeserved areas versus regular areas.”

CalPERS’s $27 billion private equity program has been the retirement system’s best-producing asset class over the long-term with investment results of 12.1% over the five-year period ending April 30, 2018, 8.7% over the 10-year period and 10.7% over the 20-year period.

Eliopoulos said in Phase I of the underserved and disadvantaged private equity program, which began in 2001, nine of 10 private equity managers “underperformed quite significantly from a return standpoint,” leading to an overall -5% investment return. CalPERS statistics show that $475 million was invested in nine managers and a 10th fund of funds, managed by an overall manager who then hired 15 separate fund managers.

He said one of the 10 managers had exceptional performance, which brought up the overall return of Phase I. Megan White, a CalPERS spokeswoman, said in an email that overall the return for Phase I was 12% when the one manager’s results are calculated with the other nine managers.

CalPERS statistics show that manager, GCP Capital Partners of New York, which managed the GCP California Fund, had an internal rate of return of 94% in its now liquidated fund. Eliopoulos said the fund had strong performance because of investments in one particular portfolio company, which he did not name.

All of the funds in Phase I have all been liquidated except two, said White.

Still active is the California Community Venture Fund, the fund of funds managed by HarbourVest Horizon, consisting of 15 separate private equity funds. A second single private equty managed by private equity firm Yucapia Companies is also still active, she said.

CalPERS statistics show that the California Community Venture fund of funds had an internal rate of return of -0.8% for a 14-year period between 2003 and Sept. 30, 2017.

The Yucapia fund, The Yucapia Corporate Initiatives Fund I, had an internal rate of return of -5% from its founding in 2001 through September 30, 2017, the statistics show.

Eliopoulos said Phase II of the program, which began in 2006, used a fund of funds approach entirely. The Golden State Investment Fund was made up of 16 private equity funds and 17 co-investments which received a total of $560 million for investments. The fund is managed by alternative investment firm, Hamilton Lane.

Eliopoulos said at the June meeting that overall performance was improved from Phase I, an internal rate of return of 8.2 % as of Sept. 30, 2017, but the second-quartile performance still did not meet performance expectations of the overall private equity program. Some of CalPERS private equity managers in the system’s top quartile have IRR’s of 20% or more.

With many funds in Phase II also wrapping up, CalPERS official said the 13th annual California Initative report that was released at the June 18 meeting will be the last.