What Will CalPERS’ Reallocation Plan Mean for Private Equity?

In mid-December, Real Desrochers, senior investment officer for the California Public Employees’ Retirement System (CalPERS) fund, indicated that CalPERS would reduce the number of private equity investments from 389 to 120.  The reason for the strategy announcement:  the CalPERS board felt it is currently over-diversified, making it difficult for CalPERs to generate above-median returns.  What does this (potential) change mean for the private equity world?

Pitchbook, a private equity data collection and analysis firm, recently put out some figures on CalPERS and private equity commitments.  Here is what Pitchbook has as the highest and lowest performing private equity managers with CalPERS money:

• The top performing fund is the Carlyle/Riverstone Global Energy and Power Fund, with a KS PME score of 2.62, followed by Granite Global Ventures at 2.54, and Newbridge Asia III at 2.50.
• On the other end, the three worst performing funds are American River Ventures at 0.01, NGEN Partners Fund II at 0.08, and Healthcare Focus Fund at 0.13.

Some of these, and other prominent firms, such as Apollo, Blackstone, and Advent, will likely see CalPERS investments dry out once CalPERS slowly starts to implement their reduced private equity investment plan.

In addition to these financial firms, CalPERS professionals indicated a desire to limit exposure to fund of funds.  According to Pitchbook, CalPERS has been on this path since 2009, with only one fund of funds commitment since 2009, compared to at least 14 fund of funds holdings from 2006 to 2008.

In addition to the large private equity funds and fund of funds managers, CalPERS will also likely limit exposure to venture capital firms, given that VC firms have been the bottom rung performing asset class over the past ten years, including the past one and three years.  Lastly, Pitchbook indicated that 25 underperforming investment managers with initial and only investments coming between 2004 and 2009 will likely be dropped.

Outside of the four groups likely to see decreased cash flow, the last remaining question is: what will the CalPERS board strategy mean for startup companies or companies looking to be bought out?  The jury is, of course, still out on this.  Presuming you’re not one of the left-out-in-the-cold investment managers, decreased assets within the asset class might be good for the private equity industry as a whole, in that less cash chasing the same number of deals may lead to higher returns.

Overall, the move by the board of CalPERS to reduce the number of private equity investments is a big shift in confidence away from the “classy” asset class.  Interestingly, of the CalPERS’ asset classes, private equity has been one of the better performing.  Besides impacting some very well-known (and some unknown) investment managers, it is yet to be seen whether the change will impact, in any significant way, the private equity and venture capital industry as a whole.