Healthy private equity returns helped the US$446 billion California Public Employees' Retirement System (CalPERS) beat its -7.0% benchmark return with a -6.1% net return on the financial year ending June 30.

A 21.3% net return on private equity far exceeded the state-administered pension fund’s 8.3% return for the asset class, which helped offset the poor performance of public equity (-13.1%) and fixed income (-14.5%) – both achieving no alpha. According to the fund, public market investments make up roughly 79% of the CalPERS’ total portfolio, which exposes it to massive risk. While real assets also showed a positive return of 24.1%, the asset class still missed the 27.1% benchmark. Since the beginning of the calendar year, CalPERS has lost US$55 billion in value – a decline of around 11% - as the impact of the Ukraine crisis rocked markets.

CalPERS Chief Investment Officer Nicole Musicco, who was appointed in February after a long search, said, “This is a unique moment in the financial markets, and we’ve seen a deviation from some investing fundamentals. For instance, our traditional diversification strategies were less effective than expected, as we saw both public equity and fixed income assets fall in tandem. But despite a challenging year, we were able to outperform our total fund benchmark by 90 basis points and provide strong returns from our private market asset classes. These are bright spots that we can build on as we implement our new strategic asset allocation and increase our exposure to private market assets.”

Total fund annualized returns for the 5-year period ending June 30, 2022 stood at 6.7%, the 10-year period at 7.7%, the 20-year period at 6.9%, and 30-year period at 7.7%. With CalPERS’ discount rate of 6.8%, the estimated overall funded status stands at 72% - a level that falls well short of where the fund needs to be to serve is members.

CalPERS is overhauling its private markets strategy, despite the robust performance in the private equity asset class. Earlier this month it was revealed that the fund was selling a US$6 billion slice of its private equity portfolio at a discount and cutting ties with external managers, despite its previously stated objective to raise its allocation to the asset class. The sale of 11% of its US$53.5 billion private equity portfolio is being staggered, so some will transfer in the new financial year in order to cushion the blow on the current year’s performance. According to Bloomberg’s sources, the holdings were sold at a 10% discount compared to their September 2021 value, implying the portfolio lost US$650 million of its value.

The decision puzzled many observers given that in November the Board of Administration confirmed a new investment strategy for the next four and a half years, which bringing the level of private equity back to 2011 levels, at 13% of the total portfolio.

Musicco is seeking more deal origination by the fund’s own teams rather than rely on external managers, to gain greater control. The US$6 billion in cash should give her plenty of funds to play with, but with that comes the need to bolster internal human resources. While the sale discount might seem steep, pundits have suggested the opportunity cost would have been more pronounced if CalPERS had held on, leaving the portfolio to continue to depreciate in value and leading to higher discounts in the medium-term.

Improved origination through internal teams means a hiring spree and we expect CalPERS to beef up its private equity teams in coming months as it seeks to redeploy cash from secondary markets as well as the leverage it plans to take on to drive forward an aggressive private market strategy.

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