Friday Letter: Fighting fractions

The dreaded denominator effect appears to be manifesting itself and shrinking the private equity allocations of LPs – and not just the little guys.

In a troubling development for capital-hungry GPs everywhere, the California Public Employees’ Retirement System, which has a robust $45 billion (€31 billion) private equity programme, may start tinkering with the 10 percent allocation target it increased from 6 percent just last December. And “tinkering” doesn’t necessarily mean up.

This week, the investment staff at what is one of the world’s most influential institutional investors, said the twin forces of slowing private equity realisations and distributions coupled with tanking public equities returns have thrown its asset mix off kilter – and too close for comfort to its absolute maximum of 13 percent.

“This has created a circumstance, not unexpectedly, that the allocation to [private equity] has exceeded its target, and it appears highly likely that it may exceed the maximum end of the range in the foreseeable future if the public markets do not recover and if distributions do not return to more normal levels,” the memo said.

A spokesman guessed this could possibly mean an adjustment of “a few percentage points up or down” – but when considered in the context of the $234 billion pension giant, that’s a lot of capital poised to disappear from GPs' pockets.

Just this week, for example, CalPERS disclosed more than $1.7 billion in fresh commitments to eight private equity managers including CVC Capital Partners, Asia Alternatives and TPG’s biotech fund.

In recent months, placement agents and advisory groups have predicted shifting portfolio values would affect private equity fundraising. Others suspected it would start a secondary sell-off among smaller investors with larger private equity allocations, such as endowments and family offices.

Though CalPERS has yet to make any adjustments to its private equity portfolio, the message in the memo is clear: investors’ need for liquidity is here.