Russell Read, the chief investment officer of the $240 billion (€173 billion) California Public Employees' Retirement System, wants the US Congress to know that private equity has been good to his pension. In testimony last month before the Senate Finance Committee, Read gave no clear opinion on whether carried interest should be taxed at a higher rate. But he did ask committee members to consider the beneficial effects that private equity brought to the retirees of the Golden State. Some excerpts of his submitted testimony:
“The record shows that private equity investments have significantly helped us to maximise our earnings and minimise contributions. As of July 31, 2007, the [Alternative Investment Management] portfolio had outperformed its public equity benchmark and the CalPERS actuarial rate in all periods. The AIM portfolio's one-year return was 28 percent compared with its benchmark of 15 percent. Its threeyear return was 22 percent against a benchmark of 17 percent. The 10-year return was 8 percent higher than the benchmark. The AIM Program's total return since inception was 14 percent compared with the CalPERS actuarial rate of 7.75 percent – the annualised gain on investment required to fund pension obligations.
More than 5,000 companies have received investment capital through our private equity programme, generating more than $12 billion in cash profits to CalPERS since 1990. Since the AIM Program began, the private equity industry has evolved and expanded. The asset class has become more global and institutional in nature. Private equity funds have increased dramatically. More experienced managers have emerged with differentiated strategies. This transformation has enabled CalPERS to build a diversified portfolio to meet our objectives. Our private equity fund managers invest across the spectrum of a company's life cycle – from its early stage, growth, and to maturity. This investment approach allows the AIM portfolio to be diversified by several parameters including vintage year, strategy, industry, and geography.
Generally, private equity is an attractive asset class to sophisticated investors like CalPERS because of the contribution it can make to an overall portfolio. This contribution is evident in historical quantitative performance and in the unique attributes of this asset class…”
“As a Limited Partner in several hundred private equity partnerships, CalPERS is very sensitive to the economic terms of private equity investment partnerships… CalPERS is very focused on actively negotiating all of the terms of a private equity partnership, including the economics to ensure that its interests are protected. In particular we focus on a strong alignment of interest. Historical performance data shows a strong correlation between past and future top-quartile investment performance in the private equity asset class. As an investor seeking to maximise returns for its 1.5 million pension beneficiaries, CalPERS is focused on investing with the very best General Partners globally. The very best General Partners often: charge the highest fees, are oversubscribed, and are well positioned to negotiate the legal documentation. The ability for top performing investment managers to structure “premium economics”, which may include higher fees, is not unique to private equity. For example, carried interest for the very best General Partners can reach 30 percent of net profits compared to the typical 20 percent. To reiterate, fee structures are: currently variable across funds, heavily negotiated, based on a number of factors, and difficult to reduce for the very best General Partners.
A delicate balance exists for a Limited Partner like CalPERS to be successful: achieve access into the very best private equity investments, while at the same time negotiating appropriate economic incentives for the General Partner. Due to the interrelated nature of the economics for a private equity fund, it is complicated to say generically how a change in one component will impact the total economics. As each fund is individually negotiated, an adjustment to one component will lead to offsetting negotiations on other components…”
“CalPERS' historical performance indicates that on a net basis, attractive returns can be generated compared to both its benchmark and the actuarial rate providing incremental benefit to its beneficiaries from investing in the best private equity funds, not the cheapest.”