CalSTRS Wants to Double Co-Investments

The investment staff of the California State Teachers’ Retirement System (CalSTRS) wants to double the number of co-investments in the system’s approximate $18 billion private equity program in the next two to five years, adding 15 new staffers and possibly opening an office in San Francisco to handle the additional investments.

The West Sacramento-based pension’s plan to build its private equity program is contained in agenda material for its January 30 investment committee meeting. The investment committee is being asked to approve CalSTRS’s strategic direction in efforts to expand the private equity program, the pension system’s best-producing asset class over the short and long term.

CalSTRS’s overall private equity returns for the one-year period ending March 31 totaled 15.5%, the largest return of any asset class.

CalSTRS currently has 8.1% of its overall portfolio devoted to private equity, but its long-term target is 13%.

CalSTRS investment officials see co-investments as a way to get to that target. Co-investments only account for a small part of the plan’s private equity portfolio, around 5%, said a September report from the Meketa Investment Group, which serves as a CalSTRS investment consultant.

The new January 30 plan said that over the last two calendar years, the CalSTRS private equity program has made new commitments of approximately $6 billion to $7 billion a year with co-investments representing approximately 8% to 9% of total new commitments.

The plan says private equity’s current team of 23 professionals, 18 who specialize in investments and five operational personnel, are at capacity for the current investment pace and that an additional 15 hires are needed to at least double co-investments.

CalSTRS paid more than $500 million in management and profit-sharing fees to its private equity general managers in calendar year 2017, the most recent data available. The CalSTRS plan says that  “increasing co-invest represents the most immediate, largest, and greatest opportunity to reduce costs and increase investment returns.”

Under co-investments, CalSTRS and other pension plans are offered additional stakes in portfolio companies acquired by private equity firms, often at little or no additional fees. This is usually in addition to the pension plan’s investment as a limited partner in a co-mingled fund with a general partner.

Officials of the $214.9 billion CalSTRS see co-investments as a possible entry point to make direct investments in private equity at a later point without external managers.

CalSTRS’s approach contrasts with that of its larger Sacramento neighbor, the California Public Employees’ Retirement System (CalPERS), which is proposing to invest $20 billion in additional private equity funds through two direct-style investment vehicles. One vehicle, called Innovation, would take stakes in late-stage companies in the venture capital cycle. The other vehicle, known as Horizon, would take buy-and-hold stakes in established companies. CalPERS currently has around $28 billion invested in private equity.

The CalSTRS plan says the competition for high-quality co-investment professionals “makes it advisable to budget for a higher average salary for such professionals” than existing personnel. It does not state, however, what the new staffers should be paid. 

The plan also says that private equity investment staff to be hired for the expanded co-investment program “would be significantly enhanced by being located in a major financial center.”

It says that while public asset classes are largely research-oriented, private asset classes are more relationship-oriented.

“In major financial centers, investment professionals have more opportunities to interact and form

relationships with other investors, lenders, investment bankers, consultants, advisors, regulators,

lawyers, and operating company executives,” the plan says. “Such an ecosystem is more efficient and is likely to result in a higher level of knowledge, competitiveness, and overall flow of opportunity.”

The plan says San Francisco is an “obvious choice to consider” for the co-investment expansion because there are many general partners located in the Bay Area, including KKR, TPG, and GI. It also said that other major institutional investors, including Singapore’s GIC sovereign wealth fund and the Queensland Investment Corp., have placed private equity professionals in the Bay Area.

CalSTRS is the second-largest US fund by assets, surpassed only by the $345.6 billion CalPERS, which is No. 1.