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PE Panorama: Oh, CalPERS

Man in blue suit holding lightbulb
By Paul Mackintosh  
June 29, 2020

Opinion is, to say the least, divided over California Public Employees’ Retirement System (CalPERS) Chief Investment Officer Ben Meng’s plans to increase exposure to alternatives and take on leverage. The headline of a posting in US financial news blog Naked Capitalism bawled that “CalPERS Plans to Blow its Brains Out”, while others defended Mr. Meng’s plans for the US$400 billion pension giant.

As extensively disclosed to the media prior to a briefing with the CalPERS investment committee on June 15, Mr. Meng is planning to move deeper into private equity, diversify into private debt, and lever up the pension fund’s portfolio assets by up to $80 billion, to cover the gap between the 7% target return needed to meet the fund’s long-term obligation, and the 6% predicted actual return. Citing Mr. Meng’s figures, Bloomberg says private equity will return an estimated 8.3% versus 6.8% for equities and 2.8% for bonds. “There is no alternative,” Mr. Meng is quoted as saying.

CalPERS’s investment committee apparently believed him. Mr. Meng reportedly told them that the fund would deploy leverage gradually, taking advantage of the current low cost of debt. He also plans to increase allocation to buyout funds within the overall private equity strategy.

Should California’s state pensioners feel reassured? I doubt it. For one thing, for all CalPERS’s bellwether status in US pensions, this is the fund that had one of the most notorious private equity-related scandals of all, the Fred Buenrostro/Alfred Villalobos placement debacle, which first broke in 2010.

Residual issues have dragged on almost to the present. According to reports from The Wall Street Journal picked up by Naked Capitalism, CalPERS made private agreements with the five private equity firms that benefited from Mr. Villalobos’s cronyism for reimbursement in the form of future fund fee breaks. The reports indicate that CalPERS never got back the bulk of the money privately promised. Mr. Meng is supposed to be part of the new broom that’s swept CalPERS clean since 2010, but I’m concerned that its institutional and structural flaws still remain to be fixed.

That’s just one more sign of what worries me most about this whole arrangement – CalPERS’s investment competence, internal oversight, and overall structure and culture. Everyone agrees that leverage has to be managed carefully in order to avoid goosing shortfalls in exactly the same way it’s supposed to goose returns. Most of the betting appears to be that CalPERS has at best an even chance of reaching that 7% target, even under the new plan.

Based on their competence to date, would you bank on CalPERS being able to do it? If I was a California state employee, I’d be looking at moving to Canada, for more than just the maple syrup and the ice hockey. Decent public healthcare – and well-run, fully-funded pension plans.