Warning lights are flashing on the declining performance of private equities compared to public stock markets, and sophisticated investors such as CalPERS are well aware that the high returns of the early 2000s are gone.
Median returns for private equity funds launched since the financial crisis have failed to beat the stock market by enough to compensate for increased risk. Pension plans know that high prices paid to acquire companies today mean lower future returns.
So does the pension giant plan to reduce its $26.2 billion allocation to private equity? Is it going to outsource management of these investments, pay fees and risk even lower returns?
Instead, staff is asking the California Public Employees’ Retirement System board this week to lower the bar. This may make private equity investments look better, but will do nothing to assure that these investments earn adequate returns.
The current benchmark is two-thirds U.S. stocks, one-third foreign plus 3 percent for the added risk. The proposed benchmark gives less weight to better performing U.S. stocks and cuts the risk premium to just 1.5 percent.
Does the staff believe that investing in private equity has become less risky? Or is this an admission that returns will be lower? Perhaps the staff is just looking for an easy “A.” The new benchmark will be much easier to beat and practically guarantees them a good grade.
The CalPERS board is charged with overseeing the prudent investment of taxpayer dollars and protecting the retirement earnings of workers. It should reject the new benchmark and require an honest assessment of future prospects for private equity performance. And it should ask the staff for serious recommendations for how to address lower returns.
Eileen Appelbaum is an economist at the Center for Economic and Policy Research in Washington, D.C. She can be contacted at firstname.lastname@example.org.