Friday Letter: Keeping the faith

Two of private equity’s most influential investors this week reported staggering losses in their private equity portfolio values. But their dedication to the asset class remains unwavering.  

The golden state’s agenda-setting pension schemes revealed extraordinarily dark returns this week.

The California Public Employees’ Retirement System (CalPERS) soberly called it “the most severe single year decline” in its entire history. For the fiscal year ended in March, the $185 billion public pension reported declines in its private equity holdings of 31.4 percent, while its overall portfolio value fell 23.4 percent.

Meanwhile, the $119 billion California State Teachers’ Retirement System (CalSTRS) saw its private equity investments drop 27.6 percent in value over the fiscal year ended 30 June, with total assets declining 25 percent.

But despite private equity returns faring among the worst for both ‘PERS and ‘STRS, neither is backing away from the asset class. Far from it.

Each has – or soon will – retool their allocation matrixes to give a smaller percentage of cash to public equities and or fixed income strategies, shifting those extra percentage points to alternative asset classes. Some industry observers have waved off such incremental increases to private equity allocations – a 4 percent private equity boost by CalPERS and 1 percent by CalSTRS – as simply addressing existing misalignments. The pensions are just fiddling with formulas to bring already over-weighted allocations back in line with a target range, they argue.

But the fact that these are not huge changes is, in itself, “a real message”, CalPERS CIO Joe Dear pointed out last week. 

CalPERS made the unusual move last week of releasing a Q+A video with Dear that centred on the pension’s present and future investment strategy amid today's volatility. After 2008’s dismal financial climate, he said, CalPERS’ board “looked at the long term return assumption and basically said we don’t see a significant reason to change. That is, we didn’t reduce the expected returns significantly, some minor adjustments. That’s a very powerful statement about our belief in the future.”

Other recent moves and remarks by the influential LPs further highlight their confidence that private equity funds are a crucial part of the road to recovery. For example, CalSTRS has funnelled 5 percent of its allocation to global equities to create a programme dubbed “equity return”. The programme aims to buy “quality” assets from distressed sellers across real estate, private equity and fixed income strategies.

Dear’s video also acknowledged the pivotal role of private equity managers who target opportunities arising from financial downturns and recession. “We have over $21 billion dollars invested in private equity today and another $20 billion of committed uncalled capital,” he said. ”That is capital that is available to managers … who spot an opportunity, can call that capital and put it to work. I feel pretty good about the opportunities that are out there today.”

While the Californian pensions are not unleashing a torrent of fresh cash into alternatives (how could they?), private equity fund managers should be heartened by their emphatic endorsement of the asset class’ long-term prospects and present opportunity set.

Better news still: what 'STRS and 'PERS have done sets a precedent other LPs are likely to follow.