Calpers chases low cost, high returns with new PE targets

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The nation’s largest public pension fund is moving to extend its foothold in the private markets and continue its push into low-cost investments with higher returns.

The investment committee of the California Public Employees’ Retirement System, with around $491 billion under management, voted to increase its private equity and private debt allocations Monday.

The new plan increased its PE allocation target to 17%, up four percentage points from its previous target.

The plan’s new private debt target is 8%, up from 5%.

This recalibration will increase the fund’s total private market investments from 33% of its assets to 40%.

“This [choice] is part of a long-standing migration to the private markets, where there is a little bit taken from public equity and put into private equity and fixed income is put into private debt,” said Anton Orlich, managing investment director for the plan’s private equity group, during the investment committee meeting.

Under the new portfolio construction, the plan’s public equities exposure will decrease by five percentage points and its fixed income exposure by two percentage points.

Calpers votes to increase its PE, private debt exposure

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Current policy weights
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Newly adopted policy weights

A consistent allocation pace

The newly instated target will allow Calpers to maintain consistent allocations to PE co-investment deals. Typically with no carried interest or fees to pay, co-investment structures are an ideal, low-cost option for the public pension plan.

Co-investments have also generated the highest returns of any investment type for the pension’s PE portfolio.

Calpers’ private equity group operates under a $15 billion annual allocation budget. By steadily increasing the PE allocation targets from, for example, 9% in 2022 and 10% in 2023, the plan retains its ability to maintain its allocation pacing.

“That $15 billion budget gets us to 17%,” said Dan Bienvenue, Calpers’ interim CIO. “If we were to stick with 13%, we would actually have to back off from [allocating]. It’s important to note that if we were to back off, what suffers is the co-investment.”

Without increasing the target, Bienvenue said the fund investment would stay the same but the co-investments would “drop off.”

Historically, the plan has gained its PE exposure through traditional fund investing. But now, Orlich’s team aims to reserve 50% of its annual allocation budget for co-investments. The other half goes into traditional PE funds.

In 2023, for example, 47% of the capital deployed from Calpers’ PE portfolio went into low- or no-fee capital structures, such as co-investments, as a part of this strategic plan.

The ultimate goal for Calpers’ PE portfolio is to be “self-sustaining,” meaning returns from current co-investments would pay for future co-investments. This would be feasible with a target PE allocation in the high teens, Orlich said.

“That is the state of a healthy portfolio: We have the majority of our net asset value at attractive cost structures and the harvesting of those investments pay for our future investments,” Orlich added.

Still, the plan’s entire PE portfolio, valued at nearly $70 billion, has a long way to go in terms of co-investments. As of Dec. 31, 2023, 57% of its PE portfolio’s NAV was invested in funds and 9% in co-investments.

The lost decade

The expansion in private market exposure is doubly important for the pension plan, which missed out on the PE industry’s exponential growth between 2008 and 2018 in what former CIO Nicole Musicco deemed the “lost decade.”

During this period, Calpers’ returns trailed its peers in almost every asset class, particularly in PE, which had the widest performance gap.

In her departing comments to the pension plan’s investment committee in September, Musicco referenced resistance to her plan to overhaul the pension’s portfolio with private market exposure. The board’s tendency to err on the side of caution was reflected in Monday’s extensive deliberations.

Board members questioned the necessity of exposing the portfolio to more liquidity risk and questioned the labor practices of some PE dealmakers.

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