CalPERS hopes to have finalists for independent PE platform by early 2018

California Public Employees’ Retirement System is moving forward with plans to bring on an outside firm to manage its $25.9 billion private equity program, according to internal documents obtained by Buyouts Insider, publisher of VCJ.

CalPERS is searching for a firm to monitor and select its future PE investments, Nov. 13 staff presentation materials seen by Buyouts Insider say. Investments could include PE fund investments, sponsored or co-sponsored buyouts, co-direct investments and long-term public equities, the documents said.

New investments would be selected “in close partnership” with the $341.3 billion system’s staff. CalPERS’s noncore PE portfolio and existing fund, co-investment and separately managed account holdings will continue to be managed and monitored by its staff.

CalPERS staff plans to introduce the two best candidates to manage the platform to CalPERS’s investment committee in the first quarter. The goal is to launch the new partnership “as close to the new fiscal year (July 1, 2018) as possible,” the staff presentation says.

Earlier this year Bloomber reported CalPERS was considering hiring BlackRock to manage some or all of its private equity program. Whichever firm takes the portfolio’s reins should avoid direct competition with the system’s existing GPs, which include major relationships with Blackstone Group, Carlyle Group and Silver Lake, according to the staff presentation.

CalPERS’s criteria for a potential outside manager includes an ability to commit “a material amount of their own capital alongside the investments they select for CalPERS,” the staff presentation says. The firm would also have to act as a fiduciary and “champion” of the system’s guidelines on environmental, social and governance issues, as well as sustainability.

CalPERS spokesman Wayne Davis declined comment on items presented in closed session. BlackRock declined comment.

Structure and cost

How CalPERS would ultimately structure or govern its new external PE platform is unclear. But Larry Sonsini of Wilson Sonsini Goodrich & Rosati outlined how such an entity might function at the retirement system’s Nov. 13 investment committee meeting during closed session.

According to Sonsini’s presentation, the staff of this independent outside manager would effectively manage the CalPERS account full-time. CalPERS could also set up an outside advisory board to oversee the platform and the system will have “full transparency into the funds, operations, books and records,” the Sonsini presentation says.

Each year, CalPERS and its outside manager would negotiate a dollar-denominated management fee “to fund reasonable operating expenses and market competitive compensation,” the Sonsini presentation says. The platform’s staff could also receive incentive-based compensation based on performance metrics and net profits, “instead of traditional carried interest.”

CalPERS could also structure the vehicle as either evergreen a limited partnership or limited liability company, with the ability to bring on outside institutions as limited partners at CalPERS’s discretion, the Sonsini presentation shows.

Buyouts previously reported CalPERS was exploring forming an outside PE platform with other institutional investors, such as UC Board of Regents.

Whether the new structure would reduce the cost of CalPERS’s PE portfolio is unclear, as it would likely still be on the hook for any underlying management fees or carried interest paid to fund managers accessed through the independent platform.

In its financial statements, CalPERS does not regard the underlying fees and expenses paid through funds-of-funds to be an investment-related cost. However, those costs are generally reported to the board separately.

Sonsini could not be reached for comment.

The “Core 30”

In addition to addressing the long-term structure and strategy of its private equity portfolio, CalPERS is also in the process of assessing the impact of its “Core 30” strategy, which would have reduced its number of active relationships with PE managers.

At CalPERS’s Nov. 13 meeting, consultant Meketa Investment Group reported the decision to slash CalPERS’s PE relationships to just 30 core managers may have made it more difficult to commit capital over the past two years.

Furthermore, the strategy’s goals — which include bolstering negotiating leverage around fees, increasing co-investment and separate account activity, and reducing staff’s workload — haven’t been met.

“What I’ve heard from [CalPERS] staff more recently is that they would look to have some more than just 30 managers on their list,” Meketa’s Steve Hartt said during the meeting. “I don’t think there’s been a decision as to exactly how many, but I know that other plans do have a larger set [of managers they’ll commit to].”

CalPERS’s investment committee tasked Meketa, along with CalPERS staff, to research the effects of the Core 30 strategy and address some of its shortcomings.

Action Item: For more on CalPERS, visit: www.calpers.ca.gov

CalPERS headquarters in Sacramento, California, Oct. 21, 2009. Reuters/Max Whittaker