Five takeaways from CalPERS’ investment committee meeting

The $362 billion California Public Employees’ Retirement System spent a large portion of its Tuesday investment committee meeting discussing its private equity programme. The pension fund’s plans to revamp the programme include a substantial direct investment programme. Here’s what we learned from the session.

1. There’s a new interim CIO

This is chief investment officer Ted Eliopoulos’s final week with the pension fund and newly-named CIO Yu Ben Meng won’t be taking up the post until January. Eric Baggesen, managing director for asset allocation who has been at the pension fund for more than 14 years, is stepping in during the interim.

2. The new direct investment buckets could be $10 billion – each

In May, CalPERS announced plans to launch a direct private equity programme. The proposed programme would make up two of four “pillars” of the overall private equity programme. One, called “innovation”, would be dedicated to late-stage venture capital “at the nexus of life sciences, healthcare and technology”, while the other, “horizon”, will make longer-term investments in “core economy companies”.

The other two pillars, which already exist, are CalPERS’ emerging manager programme and its traditional commingled fund platform, which it’s calling “strategic partner”. The latter will “form the major substantial part of our private equity programme going forward”, Eliopoulos said, and with co-investment will expect to make commitments of $5 billion to $7 billion per year.

Both direct investment pillars are expected to grow to around $10 billion over the course of the next decade, with the former investing at a rate of $1 billion to $2 billion a year and the latter making larger, less frequent investments.

This should help the pension get closer to a proposed 10 percent allocation to the asset class, which would require deploying $10 billion to $13 billion per year. The private equity staff committed $5.3 billion in the fiscal year ending 30 June.

Both vehicles would be designed with no fixed term and would operate independently of CalPERS with a clear definition of their mandate and regular interaction with CalPERS staff. Their own board of advisors would advise the management team on adhering to that mandate, succession planning to ensure the vehicles remain perpetual entities, reviewing the operating budget, and providing counsel and advice on other matters such as sourcing.

Cole said the combination of the four pillars would provide CalPERS the ability to invest at scale, take advantage of the economies that come with that, and therefore bring fees down over the long run.

3. There’s a lot that’s new about direct investment – but a lot that’s old, too

Eliopoulos stressed to committee members that while the new pillars offer things the pension plan hasn’t had before – longer-duration partnerships and investments that more closely resemble CalPERS’ own investment horizon; the ability to specify the investment objectives, which is not possible in commingled funds; and the possibility for better alignment of interest – there’s much that is “really old, and tried and true”, namely the partnership structure.

After much discussion, CalPERS settled on a GP-LP structure for its directs programme that it has used “hundreds and hundreds of times over the last couple of decades” in its real estate and infrastructure portfolios. The partnership will be structured as a separate account with one LP – CalPERS – and one GP. Separate accounts are “right within the core competencies of our staff”, Eliopoulos said.

4. The pension is using a new benchmark

On 1 July CalPERS changed its policy benchmark. The pension previously used a blended benchmark comprised of two-thirds weighting to the FTSE US Total Market Index return and one-third to the FTSE All-World ex-US Index return plus 300bps, lagged by one quarter. The new benchmark is a custom FTSE Global All-Cap index plus 150bps.

This lower benchmark clearly reflected positively on performance; the plan missed the previous benchmark by 2.5 percentage points on a 1-year basis, but only missed the new benchmark by 0.8 percentage points, according to a document prepared by Meketa.

The switch led to some questions by board members. In response, Baggesen said there is no good benchmark for private equity; rather, investors must decide for themselves how much outperformance they believe is rational given the state of the market. The asset class has exceeded the return available from the public market across all time periods and is not “easily substituted” by something else. In fact, Baggesen said, according to the fund’s forecasts, private equity is the only asset class with projected returns greater than 7 percent – the plan’s required rate of return.

5. There’s a possibility the plan will need to staff up

During the question-and-answer portion, board member David Miller asked what the “capacity and capability constraints” for the team were to build out pillars three and four and get more private equity funds deployed. The committee was set to discuss this in further detail in the closed-door session.