Some call them “much-vilified financiers,” as if they were the bad guys of Wall Street, even though they really don’t work there.
But private equity has been more profitable than regular stock for CalPERS, yielding an annualized return of 9 percent during the past decade compared to 2 percent for a stock index.
At a CalPERS investment committee workshop last week to consider post-crash adjustments, increasing the private equity target from 10 to 15 percent of the $178 billion portfolio was the major tweak that will be brought back for action next month.
The consensus among long-term forecasts from five consulting firms is that the CalPERS private equity program, called Alternative Investment Management (AIM), will have an annual return of 10.4 percent compared to 7.4 percent for public equity or stocks.
Before showing a number of possible portfolio alternatives, Andrew Junkin of Wilshire Consulting said he wanted the committee to be aware of the CalPERS self-imposed constraints that limit private equity to 5 to 15 percent of the portfolio.
“If you didn’t have that constraint you might end up with a portfolio that has 35 percent private equity, which could be distasteful on the risk,” said Junkin.
Private equity is generally regarded as being more risky than stocks. But when the stock market crashed last fall, the CalPERS private equity program apparently held up better than most stocks.
During the year ending last March 31, CalPERS says the value of its AIM private equity fell 19 percent while a stock index plunged 36 percent. (See the AIM performance chart here, page 10.)
So, what is “private equity?”
It’s a type of investing mainly available to institutional investors with large sums of money, such as the California Public Employees Retirement System, which usually means taking control of a company or putting new capital into it.
A common private equity investment is the “leveraged buyout.” Investors buy a controlling interest in a company, sometimes using the assets of the targeted company to borrow, and install new management to improve performance.
CalPERS had 60 percent of its private equity investments in leveraged buyouts at the end of last year.
Among several other types of private equity investments are “venture capital” for young companies with good growth prospects and “expansion capital” for companies that need money to grow or enter new markets.
Private equity investments are long-term, regarded as “illiquid” because they cannot be quickly converted to cash, and usually have a “J-curve” with no returns for the first three or four years before the profits begin.
A report last week said that CalPERS has invested $41.1 billion in the AIM private equity program since it began in 1990, earning a $14.3 billion profit. The current value of the program is $20 billion.
If the types of private equity investments can get complicated (one of them is called “mezzanine debt financing”), so can the management of the investments, which is usually done through a partnership.
CalPERS lists three main kinds of investment managements: a partnership in which the partner invests in the companies, a partnership in which both CalPERS and the partner invest in the companies, and a “fund-of-funds” that invests in partnerships.
The selection of partners by CalPERS is a big business that has been controversial at times. Private equity firms make a lot of pitches for an investment from the big pension fund.
During the fourth quarter of last year, the CalPERS private equity program reported receiving 158 proposals. But only two new commitments from the AIM program were made during the quarter, totaling $410 million.
An article on a financial website, “Seeking Alpha,” by Tyler Durden, who is skeptical about prospects for the AIM program, says: “It seems that a vast number, maybe even a majority of U.S. private equity firms, owe their existence to CalPERS.”
A financial news service, Bloomberg, reported in April that CalPERS put $1.7 billion into Leon Black’s Apollo private equity fund last year, more than twice as much as it gave to any other manager.
CalPERS was “betting that the firm could exploit the global credit crisis,” said the Bloomberg story. “So far, the bet is coming up snake eyes.”
This month, CalPERS adopted a policy requiring the disclosure of fees paid to “placement agents,” who help private equity firms obtain investments from pension funds and other institutional investors.
The California State Teachers Retirement System adopted a similar disclosure policy three years ago. The CalPERS disclosure was a response to a scandal in New York, where officials are accused of taking kickbacks for arranging pension investments.
Last Thursday, the Carlyle Group paid $20 million to settle a corruption probe by New York Attorney General Andrew Cuomo and pledged to stop using placement agents to obtain investments from pension funds.
CalPERS has a commitment totaling $4 billion to 27 different Carlyle Group private equity funds. CalSTRS has a $1.2 billion commitment to three Carlyle funds.
Five years ago, CalPERS settled a suit filed by the California First Amendment Coalition by disclosing management fees paid to private equity firms, totaling more than $200 million a year to 416 firms.
The watchdog group was concerned about “pay-to-play” campaign contributions given by private equity firms to elected officials on the CalPERS board, former state Treasurer Phil Angelides and former state Controller Steve Westly.
A powerful labor union, the Service Employees International Union, is alarmed by the growth of private equity firms and argues on a website, behindthebuyouts.org, that they are reshaping the economy in a way that could harm workers.
“And while the industry is not a new one, private equity’s acquisitions and influence are growing exponentially, raising newly relevant questions about the impact of its business practices on American workers, businesses, communities, and the nation,” says the SEIU website.
The SEIU sponsored an unsuccessful bill in the Legislature last year, AB 1967, to prevent CalPERS and CalSTRS from investing in private equity firms owned in whole or in part by a “sovereign wealth fund” operated by the government of another nation.
Taking a positive view of private equity funds, a story in Businessweek this month says “those freewheeling and much-vilified financiers who buy companies only to sell them later for a profit” have had a rough two years.
“High-profile blowups” such as Chrysler, Tribune and Linens ‘n Things “heightened private equity’s reputation as a group of fast-buck artists who are better at destroying companies than running them.”
And the good news?
The private equity firms, possibly wiser and certainly wealthier, are said to have refilled their war chests and are now sitting on massive amounts of money, presumably thanks in part to CalPERS and other institutional investors.
“When private equity starts cranking up its dealmaking machine—and it will, eventually—the $1 trillion it has amassed could help revive the economy by pumping crucial capital into the markets,” says Businessweek.
Reporter Ed Mendel covered the Capitol in Sacramento for nearly three decades, most recently for the San Diego Union-Tribune. More stories are at https://calpensions.com/ Posted 17 May 09