CalPERS is preparing to significantly increase its stake privately held companies, moving to create two new ventures that could invest up to $20 billion outside of publicly traded stock markets.
The pension fund’s investment committee on Monday voted 10-3 to move forward with the approach, although it the proposal needs to clear one more board vote before the California Public Employees’ Retirement System can start spending money on the program.
Under the proposal, the $350 billion fund would create two limited liability companies and hire a fund manager to control new investments in private companies.
CalPERS’ chief investment officer, Ben Meng, has said the fund needs to expand its private equity investments to keep from going deeper into debt. Private equity is CalPERS’ best-performing class of investments, returning about 10.5 percent over the last 20 years and 16 percent last year.
“As I said last month, we need private equity to be successful,” Meng told the committee Monday. “We need more of it and we need it sooner rather than later.”
The proposal has given pause to some board members and members of the public, whose concerns have included the lack of public disclosure that comes with private equity investing.
The strategy typically 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.
Board members Margaret Brown, Jason Perez and state Controller Betty Yee voted against the proposal Monday. The Investment Committee includes all 13 members of the CalPERS board.
CalPERS currently has roughly $28 billion invested in private equity. It pays manager fees and shares profits with companies that manage the funds.
Under the proposal, CalPERS would adopt a new model of paying outside managers to handle a new set of private equity investments. CalPERS would be the sole investor in the two LLCs that would manage the new investments, rather than being one of many investors in private equity funds under the present model. The proposal would give CalPERS more flexibility and buying power in the growing private equity market, Meng said.
“We cannot access private equity, access private equity exposure on the scale that we need, and then there are characteristics of the conventional private equity business model that are suboptimal in terms of our needs, namely the higher fees, lower transparency and a relatively lower control,” Meng told the board Monday.
To stay on schedule with payments toward CalPERS’ debt, known as its unfunded liability, the fund has to make a 7 percent return on its investment. If it falls short of that, local governments and taxpayers and potentially public workers can get stuck owing more to meet pension obligations.
As of the end of February, CalPERS’ return rate for the present fiscal year was just 1.62 percent, Meng told the board Monday. Based on historical probabilities, the fund’s chances of meeting the 7 percent rate by the end of the fiscal year June 30 is less than 30 percent.
Monday’s vote moves the proposal forward, and allows CalPERS staff to continue conversations with potential fund managers. Another vote will be held on finalizing the strategy.