‘CalPERS Direct’ Isn’t Exactly Direct

It’s called “CalPERS Direct,” but the California Public Employees’ Retirement System won’t own or direct the investments of the two planned entities that would invest $20 billion over the next decade in an alternative private equity program being set up by the largest US pension plan.

Ted Eliopoulos, who left the job of chief investment officer (CIO) of the $361.1 billion CalPERS on Nov. 16, offered some additional details on the proposed program last week, detailing that CalPERS will be part of two investment partnerships with general partners, but won’t own a stake in them.

CalPERS plans to allocate $20 billion to two partnerships, one that would invest in later-stage companies in the venture capital cycle in technology, life sciences, and healthcare. The second would buy stakes in established companies like Warren Buffet and hold those stakes for extended periods of time.

Eliopoulos told the investment committee at its Nov. 13 meeting that the pension plan’s investment staff had looked at CalPERS running the program itself or owning it directly as a captive company but what “we really settled on is the traditional partnership structure where you have a general partner and a limited partner.”

He said that CalPERS already has been part of those partnerships in its infrastructure and real estate areas, and has experience in those arrangements.

Just who the general partners are and what their compensation will be remains a key question.

While it has not yet approved the new private equity plan, the CalPERS Investment Committee has given the authority to investment staff to talk with potential general partners about the plan, including compensation of the general partners.

It has been acknowledged by private equity experts and CalPERS staff that top-notch investment personnel with a proven track record of investment success will need to be hired to lead the new investment vehicles. It would not be unusual for such compensation to be in the multi-million-dollar range, say private equity experts and CalPERS officials.

John Cole, a CalPERS senior investment manager helping develop the new private equity program, put it bluntly at the Nov. 13 meeting, saying the investment personnel hired to staff the CalPERS-backed private equity investment organizations would need to “receive competitive and compelling economic incentives.”

Critics of the plan say it is misleading to call the program “CalPERS Direct,” since the pension system will not make direct investments in private equity, like some of the Canadian pension plans.

“What they are proposing makes no sense,” said J.J. Jelincic, a former CalPERS Investment Committee member as well as a former CalPERS investment officer. Jelincic said Eliopoulos and other CalPERS investment officials haven’t detailed a logical rationale as to why they are giving up control of investment decisions or showed that they will be saving on the high fees that are part of CalPERS’s traditional private equity program.

CalPERS would be the sole limited partner in the private equity partnerships, Eliopoulos told the investment committee at the Nov. 13 meeting, allowing the retirement plan to “specify what CalPERS wants within the portfolio and much more directly.”

Eliopoulos said that one of the planned investment vehicles called Horizon, which would make buy and hold investments in established companies, would allow CalPERS to be long-term investors beyond the normal cycle of a private equity fund. He said it would allow CalPERS to “create a partnership that we can set in evergreen [or as] indefinite investments.”

 The other vehicle, Innovation, would allow CalPERS to capitalize on the increasing number of companies that are staying private longer in the technology, healthcare, and life sciences fields, Cole said.

 He said the number of companies staying private longer has grown dramatically.

 “And along with that, the size of companies that are private has also expanded dramatically,” he said.  “We’ve referred to the term unicorns, that’s companies with a market capitalization greater than $1 billion. There are now hundreds, not only in the United States but in China and elsewhere around the world.”

Cole said those unicorn companies can make attractive investment opportunities for the Innovation investment vehicle.

Eliopoulos told the investment committee that Horizon and Innovation would operate independently of CalPERS, with separate boards of advisors advising the entities on investments. He did say CalPERS staff would have routine interaction with the partnerships, including the CIO, the chief operating investment officer, the head of private equity, and the head of sustainability.

CalPERS plans to keep its traditional $27 billion plus private equity program, consisting of mostly co-mingled funds, alongside the planned new program.

The traditional program is the largest private equity program in the US, but CalPERS has seen its private equity allocation slip from 12% just a few years ago to less than 8% today because of the competition from other institutional investors to get into co-mingled funds.

The shrinkage is concerning to CalPERS officials because the private equity program has been CalPERS’s best-producing asset class over the last 20 years. In the last fiscal year ending June 30, the private equity asset class returned 16.1 %, substantially larger than the pension plan’s overall return of 8.6%. CalPERS is only 71% funded.

Cole told the investment committee that “CalPERS Direct” will be a way to increase the private equity allocation.

In a surprising statement at the Nov. 13 meeting, he echoed some of the criticism made by opponents of traditional private equity funds, including the use by general partners of financial leverage and cutting jobs at the portfolio companies they acquire. He noted that the standard “playbook” in private equity “often emphasizes the use of leverage and paying out dividends quickly and early, cutting costs, and often selling assets.”

Cole said that “CalPERS Direct” will give the pension the chance to move beyond those practices to create “longer-lasting structures” that will “distinguish ourselves in the marketplace.”

After Cole finished his presentation, one CalPERS Investment Committee member, Margaret Brown, objected to his overall remarks, stating that the investment officer was talking like the investment committee had already approved the new private equity plan.

Brown has been one of the biggest critics of the plan. She says that CalPERS officials have not produced financial metrics that show the program can succeed or justify the independent arrangement that gives CalPERS a lack of control over investments.

Most of the CalPERS Investment Committee is in favor of the plan. A final vote could come as soon as next month or early next year at the latest.