The market chaos triggered by the coronavirus pandemic played havoc with a few public LPs’ ability to measure their private equity performance.
Now, at least one is taking steps to change it.
Los Angeles City Employees’ Retirement System‘s investment committee last week approved a recommendation to switch its private equity benchmark from the Russell 3000 index plus 3 percentage points to the Cambridge Associates US All PE benchmark.
NEPC’s Carolyn Smith said the proposal came as a result of the difficulty of matching up private equity returns to public markets during times of volatility. This issue came up at a previous meeting last year, as sister title Buyouts reported. Smith said the Cambridge benchmark would give the pension system a better idea of its private equity portfolio’s performance.
“It compares your performance versus a very, very broad universe of other private equity partnerships,” she said.
The Russell 3000 is a public market benchmark. Pension systems use it to measure whether or not private equity is giving them a premium over the public markets.
The problem is that PE returns lag by one quarter, meaning that when reported on a quarterly basis the private equity returns are being compared to public market returns from three months later, subject to different short-term market conditions. When the public markets experience volatility, this can cause confusion about how well PE holdings are actually performing.
The pension has been using the Russell 3000 plus 3 percentage points since February of 2012. Before that, it used the Russell 3000 plus 4 percentage points. Together, these are referred to as the “private equity blend”.
NEPC’s presentation showed that for the first quarter of 2020, its private equity portfolio returned 3.48 percent over three months. Meanwhile, the private equity blend returned -20.26 percent, reflecting the collapse in the public markets at the time, for an excess of 23.74 percentage points as of 31 March 2020.
But in the second quarter, the market chaos caught up with the private equity holdings while the public markets quickly rebounded. As of 30 June 2020, PE returns were -9.57 percent over three months and the private equity blend returned 22.87 percent, for an excess of -32.44 percentage points.
To illustrate the greater clarity the Cambridge index would bring to performance evaluations, Smith mentioned a meeting last summer where the benchmarking issue came up while going over the first quarter returns.
As Buyouts reported, the committee and consultants spent a great deal of time discussing what the private equity returns really looked like amid a still-turbulent public market.
“We will spend less time talking about the imperfections of the asset class reporting and more time dedicated to what’s going on at the total fund level,” she said.
Benchmarking private equity can be difficult. Smith’s presentation also discussed the lack of transparency that comes with using the Cambridge benchmark due to individual firms’ data not being readily available. Additionally, the make-up of an LP’s particular portfolio can be very different to the make-up of the firms in the Cambridge benchmark.
“There’s no benchmark that’s absolutely the best fit for private equity,” Smith said. “This benchmark is a better fit than what we are using.”
The LACERS benchmark change will have to be approved by the full board before taking effect.
Smith said other NEPC clients that use public benchmarks were having similar discussions.
Massachusetts Pension Reserves Investment Management Board uses the Russell 3000 plus 3 percentage points as its PE benchmark. Last year, executive director and CIO Michael Trotsky described very similar issues with the benchmark being used to measure PE performance during volatile times, calling it an “apples-to-oranges” comparison, as Buyouts reported. MassPRIM is also re-evaluating its benchmarking process.
Last month, Oregon State Treasury staff discussed issues with the Russell 3000 plus 3 percentage points benchmark in reviewing its own returns. Private markets director Michael Langdon echoed Ryan, saying there were no good answers to the question of how to benchmark private equity.