California's Public Pensions Plans Riskier Investments After "Lost Decade"

The California Public Employees Retirement System plans to make riskier asset class investments as the largest state fund in the United States hunts for higher returns.

with a multibillion-dollar push into international venture capital after a decade of “lost” opportunities.

The fund could put as much as $5bn of new money into venture capital, the Financial Times reported, citing Calpers’ officials. That would make it one of the single largest US investors in the sector at a time when many funds are struggling to raise new money amid concerns about the US economy and higher interest rates.

“If you look at the highest performing private equity programmes, many of those have extremely high proportions of their private equity portfolio in venture,” Anton Orlich, Calpers’ managing investment director for growth and innovation, told the Financial Times. “So bearing that in mind, Calpers should be participating more in venture.”

Calpers decision to pursue venture capital investments comes at a turbulent moment for the asset class. Total venture funding fell 35% to $445bn, according to data company Crunchbase, while the Refinitiv Venture Capital Index fell 55% in 2022.

Management Changes

The new strategy comes after several years of turmoil and unsteady leadership at CalPERS. Until August of 2020, CalPERS long-time CIO was Ben Meng, a former Thousand Talents scholar who was meant to propel the fund's returns in the new decade.

Instead, Meng resigned in 2020 after Naked Capitalism exposed he falsified a multitude of financial disclosure documents, following a huge spike in personal trading violations by staff at CalPERS.

The pension and California regulators failed to investigate the falsified disclosures, in which Meng did not accurately describe the size and nature of his investments, including relationships with private equity firms in which CalPERS invested substantially, indicating a potential conflict of interest or quid-pro-quo arrangement.

Matters were already complicated leading up to the Covid induced market crash in March 2020. CalPERS had invested in Nassim Taleb’s tail-risk hedge fund. Taleb alleged that the decision to disinvest from two of his tail-risk funds resulted in CalPERS giving up over $1 billion gain, or a 3600% return, on the bigger of the two hedges that CalPERS closed out first.

In addition to the CalPERS’ divestiture and Taleb’s response, the Wall Street Journal described Univera’s great results on April 8, 2020. By then, its gains were even higher: 4144% year to date.

“We terminated explicit tail-risk hedging options strategies because of their high cost, lack of scalability, and the fact that there are better alternatives available to CalPERS,” said Meng.

“In December 2017, our board approved risk segmentation as drawdown mitigation managers as cheaper and more scalable drawdown risk mitigation than explicit options-based tail risk hedging strategies. As we continue to enhance our balance sheet liquidity management and develop a centralized governance structure, as part of the broader active risk review in 2019, the termination of an expensive and unscalable strategy became apparent.”

Global Concerns

Investors stopped aggressive funding of startups amid concerns about the global economy, geo-political uncertainty, plunging tech industry stock prices and growing recession fears. In the final quarter of 2022, investments in North American startups fell 63% compared to the same period a year earlier, according to a new Crunchbase report.

Calpers also saw a drop in its venture capital portfolio. In the fiscal year ending March 2023, its venture strategy recorded a 24.8% decline in performance. Calpers lost an estimated $77 million on its investments in Silicon Valley Bank and Signature Bank.

For Orlich, despite these concerns, the fund has missed out on start-up opportunities. His latest review of Calpers' $55 billion private equity program argued that "inconsistent allocation by vintage year and under-allocation to the venture strategy contributed to Calpers PE underperformance over the last 10 years."

The review compares Calpers' 10-year IRR of 12.3% in private equity returns to the Cambridge and State Street indexes' 16.2% and 14.6% IRR, respectively.

1% Target

The proposal comes as Calpers seeks to make up for what Orlich described as a “lost decade” of returns stemming from a decision to put the pension plan’s private equity programme on hold between 2009 and 2018, the Financial Times reported. Nicole Musicco, appointed Calpers’ chief investment officer in 2022, estimates this cost up to $18bn of returns.

In 2011, Calpers approved a target exposure of 1% to venture capital within its alternative investment management program, now referred to as its private equity program. At that point, about 7% of its alternative assets were allocated to venture.

Over the following decade, the institutional investor systematically chiseled its venture exposure down—5% in 2016, 3.4% in 2017, 1.9% in 2020—and finally hit its 1% target in the second half of 2021, Pitchbook reported, citing a semi-annual reviews of Calpers' private equity program done by financial consultancy Meketa Investment Group.

Venture funds vastly outperformed rival strategies during the period, culminating in a banner year for VC-backed IPOs in 2021. In 2020, the investor hired a new head of VC, Ben Lee, and began to commit more significant sums, including a $300 million check to Tiger Global and $400 million to four Lightspeed funds.

Not Just Returns

Orlich told the Financial Times that the venture capital push was not just about returns but also diversification, particularly in a period when the market expects higher interest rates. Venture capital was an asset class that did not have leverage “in a period where higher costs are going to put pressure on buyout returns,” he added.

In November of last year, the pension scheme upped its venture target to 6%. That happened shortly after Orlich was appointed managing investment director.

CALPERS shift may be strategically timed. Orlich has more than a decade of experience as a senior investment professional, most recently as the head of alternative investments at Kaiser Permanente, where he grew the alternatives allocation from 15% to over 50% for a portfolio over $100 billion.

The pace of decline in total VC deal value also appears to be slowing as both deal value and count level off, according to Pitchbook. VC-backed companies raised $37 billion in Q1 across an estimated 2,856 deals. Late stage deals fell for the seventh straight quarter, and even angel and seed-stage deals declined sharply, hitting a 10-quarter low, despite showing resilience through 2022.

Sustainable opportunities

Following its annual review of its $71 billion real assets portfolio, Calpers also plans to increase the focus of its infrastructure investments on sustainability investment opportunities, including energy transition, renewables, carbon neutral and sustainability-certified assets.

The pension fund’s real assets portfolio comprises $14.1bn in infrastructure and $56.8bn in real estate assets. Calpers wants to expand its relationships with infrastructure managers, which currently include Global Infrastructure Partners, Stonepeak, Harbert Management, QIC and IFM Investors.

The fund manages $457 billion in capital on behalf of California's 2 million state, school, and public agency employees. School members represent the largest demographic at 38%.

The fund's 13F holdings fell to $122.7 billion in the first quarter this year, compared with $128.7 billion for the same quarter the previous year. The fund had 1,215 positions, including stake in Apple Inc, Microsoft Corp., Amazon.com Inc and Nvidia Corp, in the first quarter this year, compared with 1,227 for the same quarter last year.