Private equity is in the doldrums, with groups struggling to exit investments and raise fresh capital. But one of the world’s biggest investors is doubling down on the sector.
Even as many of its peers limit their exposure to about 10 per cent of their portfolio, the $590bn California Public Employees’ Retirement System concluded its 13 per cent private equity allocation fell short. Last year it lifted its target to 17 per cent. This year, its allocation hit 18 per cent.
Sceptics — including some former board members — question whether such a high weighting is wise given the illiquidity and opacity of such investments. Critics also question the valuations of private assets whose true worth can be ascertained only when they are sold or listed.
But under chief investment officer Stephen Gilmore, who joined last year, Calpers will be aiming to emulate the benchmark-beating performance of his former employer the New Zealand sovereign wealth fund and move on from a period of low returns and high leadership turnover.
Calpers, which oversees the pensions of public workers in California, is one of the biggest investors in private equity funds in the US. It bet on the sector early, getting into the asset class in the 1990s, but lost its nerve after the financial crisis, committing less than many of its rivals.
The result was what former chief investment officer Nicole Musicco declared a “lost decade” between 2009 and 2018, and three years ago the fund decided to increase the pace of its private market investments — but with a twist.
Instead of its traditional mainstay of large buyout funds, Calpers shifted its focus towards growth and venture companies. It also moved towards co-investing alongside private equity groups, a model that comes with lower fees. Its private equity portfolio has doubled since 2022, from $50bn to $103bn, and it now has investments across about 400 funds.
So far, the pivot has paid off. Calpers’ private equity portfolio delivered returns of 14.3 per cent in the year to June and was the top performer among America’s 30 largest public pension fund private equity programmes last year — up from 17th in 2022. Tilting towards co-investments had brought its private equity fees down 10 per cent over the past two and a half years, Calpers said.
Some former Calpers board members are concerned. Private equity investors around the world have suffered lower returns since interest rates rebounded in 2022 after years of historic lows.
Money paid back from private equity funds across the industry has been lower than expected, raising questions over whether assets can be sold for the sums that price managers claim, as they cannot be priced accurately until an exit is achieved.
“We carry the private equity at the value the manager says it’s worth, we pay the manager their fee based on what they say is right,” said Margaret Brown, who was a board member of Calpers from 2018 to 2022 and is now president of the Retired Public Employees Association of California (RPEA).
JJ Jelincic, who retired from the Calpers board in 2018 and is a fellow member of RPEA, said “the one thing you know about the stated values of private assets is that they are not right, they are overstated”.
Calpers shows few signs of backing off from its contrarian bet on private equity, an asset class that has historically been its best performing. In fact, Gilmore told the Financial Times it was “reasonable to expect” the exposure to “continue to increase somewhat”.
Gilmore believes Calpers’ long history in private equity — as well as its long investing horizon and low liquidity needs — gives it privileged access to opportunities with managers in the sector.
“Size gives us a comparative advantage . . . we can be first call when it comes to co-invest,” he told the FT.
Other investors, such as endowment funds, have by comparison come under pressure to sell because of a need to realise cash, presenting an opportunity to snap up investments on the cheap. It was an “interesting time” to invest, Gilmore said.
The concerned retirees from RPEA have tasked former US Securities and Exchange Commission lawyer Edward Siedle to comb through Calpers’ portfolio. They argue that the state has been reluctant to properly scrutinise the scheme because it could raise questions about whether the generous defined benefit pensions offered are viable in the long term.
“Anything that reflects badly on Calpers becomes a challenge to defined benefit,” said Jelincic.
The results of Siedle’s probe are not yet public. But the lawyer said it was a “pivotal moment” for private equity, with the Trump administration poised to open up private equity investing to millions of private sector retirees through 401k plans. In part, that move is based on the premise that such investments have delivered stellar returns for public pensions.
Despite RPEA’s unease, Gilmore and his team may get more latitude over investment decisions rather than less. The chief investment officer and his team have recommended that Calpers adopt a “total portfolio approach”, which gives the investment team more discretion to adjust allocations across asset classes based on the level of risk the scheme wants to take.
The strategy is used by NZ Super, Gilmore’s previous employer, as well as some large Canadian and Australian pension funds, and Calpers’ leadership believes it will help improve the scheme’s funding level.
That additional flexibility may make a heavily scrutinised scheme more opaque, however.
Siedle said he was concerned that scheme members could not see underlying holdings within a private equity fund and that the total fees paid to managers were unclear, even under the current structure.
Despite that, Calpers ranks highly on transparency benchmarks compared with its peers. The fund has a valuation tracker on its website that updates daily.
Gilmore said the degree of transparency was “at another level” compared with other places he had worked and “almost all” discussions took place in open sessions where anybody could listen. He added that discussions were only carried out in closed sessions when public knowledge could negatively affect Calpers’ ability to trade and compromise the performance of the fund, in accordance with US laws.
Unlike many other defined benefit schemes, Calpers remains open. Strong returns in recent years and higher interest rates have improved its ability to meet pension payments, with an estimated funding level of 82 per cent — its highest level since 2007 and up from about 60 per cent in the depths of the financial crisis.
Gilmore said that even though the strategic changes to the private equity portfolio had been “fairly recent”, the impact on the total portfolio had been “very impressive in terms of the results”.
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