The CalPERS board will decide Monday whether to move forward with a plan to try to boost investment earnings with a higher-risk, higher-return strategy that comes with little opportunity for public scrutiny.
The state retirement fund’s new chief investment officer has pitched the plan, which involves investing up to $20 billion more in private companies, as a way to help the $350 billion fund avoid sinking deeper into debt.
“It may or may not work, and may or may not work now,” Chief Investment Officer Ben Meng said of the plan at the CalPERS board’s February meeting. “However, given our current ... underfunded status and our outlook for the global economy, doing nothing is not an option.”
The proposal is controversial and several board members have asked hard questions about it at recent meetings. The plan sets up a new approach to the private equity market, which generally involves buying private companies, making them more profitable and then selling them at a gain. That could mean CalPERS’ partners in the endeavor would be involved in cutting costs and laying off workers at private companies.
The plan would bring private equity investing a step closer to being an in-house operation at CalPERS, while not going quite that far. Fund managers would work with CalPERS, but would not be public employees. They could be paid wages and bonuses running into the millions of dollars. Their salaries would not be disclosed to the public under CalPERS’ proposal.
Today, CalPERS has roughly $28 billion invested in private equity. It pays manager fees and shares profits with companies that manage the funds. The proposal would avoid some of those charges and increase CalPERS’ stake in investments outside of the stock market.
Meng told the board the plan’s risks are necessary to meet the fund’s return-on-investment target of 7 percent per year. Missing the target drives up the pension fund’s debt, which increases costs for local governments, taxpayers and public employees.
Private equity has delivered the highest returns of any of CalPERS’ categories of investments, averaging 10.5 percent over the last 20 years and 16 percent last year. But opportunities to invest in outside funds are limited and demand for them is growing, restricting CalPERS’ ability to invest in those markets, a consultant told the board.
The California Public Employees’ Retirement System investment committee, which is made up of all 13 board members, will vote Monday whether to move the proposal forward, giving staff the ability to hire partners to run the private equity organization and find office space. Another vote and an external review would come later.
The plan’s primary risks lie in hiring the right people to run the operation and in setting it up properly, Meng, who was hired in September, told the board.
“I do see the risk in the implementation, funding the right partners, and then have the right governance and economic terms in place to make sure that the highly capable partners will be working for us, not themselves,” he said.
The private equity proposal would create two entities. One, titled Innovation, would focus on technology, life sciences and health care companies in late venture capital stages. The other, titled Horizon, would focus on long-term investments in large companies, which CalPERS is uniquely positioned to buy and hold due to its size and long-term focus, Meng said. Under preliminary plans, each would be able to invest up to $10 billion.
The lack of public disclosure of many of those details has given pause to some observers.
Without details, pensioners can’t know whether the new operation will in fact cost less or make more money than CalPERS’ current approach to private equity, J.J. Jelincic, a past CalPERS board member, told the board. Jelincic criticized the board in the past over the fees it pays private equity managers.
“Our concerns include, one, the governance model of establishing and funding these two independent corporations fully with our pension fund yet lacking transparency to stakeholders, specifically no salaries or operating costs would be revealed to us for the two general partners,” Jelincic said.
Other opponents have said CalPERS staff should take on the private equity investing in-house, rather than setting up an organization with outside partners.
“The way to go is bringing it in house, finding the right people to run the organization,” Al Darby, president of the Retired Public Employees Association, said last month’s CalPERS board meeting.
Meng said he doesn’t see that as a viable option. At last month’s meeting, he said the fund’s governance structure and its location outside of a global financial center could “hinder our ability to attract the expertise in-house.”
He’s CalPERS highest paid employee. He can earn up to $1.77 million in wages and bonuses. The New York Times in 2016 commissioned a study that showed private equity executives can earn much more money.
Meng said the proposal, which has been in the works for a year, attempts to take “smart” risks by following market trends. He said the plan takes advantage of the scale, reputation and spending flexibility of the nation’s largest public pension fund.
“More and more companies are staying private for longer,” he said. “And for CalPERS to have access to that segment of the wealth creation, we need to be in that space.”
Service Employees International Union, along with organizations representing cities, counties and special districts in California, have supported the proposal, emphasizing the need to meet the fund’s 7 percent return-on-investment target to avoid increased costs for local governments and public employees.
“In the case of local agencies, it’s borne on us if there is a shortfall,” said Dane Hutchings, a lobbyist for the League of California Cities.
As it stands, Meng said, CalPERS needs to take risks to meet its goal.
In response to a board member’s question, he put it another way: “No pain, no gain, right?”