Privately Speaking: CalPERS 2.0

Walking into the headquarters of the California Public Employees’ Retirement System (CalPERS) in Sacramento, it’s easy to forget that you’re visiting a public pension fund. The front entrance to Lincoln Plaza East, the building that now houses the investments team, is a 90-foot tower of shimmering glass and steel that feels like it should belong to a super-rich private equity firm, not one of the LPs that bankroll them. Even if that LP does have $265 billion of assets under management.

The building is a relatively recent addition to the original CalPERS HQ; it only opened about eight years ago, a mere bagatelle for an organisation that’s been going since 1932. But they’ve been a fairly eventful eight years, at least as far as the investments team is concerned. First came the boom. Then came the worst financial crisis in decades, when CalPERS saw its returns and valuations plummet. Then, to add insult to injury, came the ‘pay-to-play’ revelations. By the time Joe Dear arrived as chief investment officer shortly afterwards, in March 2009, there was a substantial job to be done to restore CalPERS’ good name.

In late 2011, Dear (who has sadly been forced to take a step back from his role recently as he fights cancer) sat down exclusively with PEI to talk about some of the steps he had been taking to clean house. And perhaps one of the most significant was the recruitment of Réal Desrochers to head up the system’s private equity investments. Desrochers had previously done a similar job at CalPERS’ sister fund CalSTRS (the California State Teachers Retirement System), where his programme had delivered returns of 17 percent over a decade. In May 2011, Dear enticed him back to the Golden State from Riyadh, where he’d been working as CIO for the Saudi Arabian Investment Company (Sanabil), to try and perform a similar trick with CalPERS’ troubled programme.

On arrival, Desrochers was given a pretty blank slate by the board (some of whom were probably wondering whether the asset class was more trouble than it was worth). His official task was to “review and define the role of private equity in the portfolio” – and all options were on the table, he insists.

The answer he came back with, however, was simple. “Private equity should be producing 300 basis points above equities. That’s its role. It’s the alpha provider for the whole system.”

But if this basically meant more of the same for CalPERS in strategy terms – the allocation to private equity remained at 14 percent, with buyouts still accounting for the majority of the total – it was clear that big changes were required in the way that the pension’s investment team operated.


The first problem was that CalPERS was spending too much money on external consultants – which, as the ‘pay to play’ scandal showed, was a risky business.

Desrochers’ response was to start bringing core functions in-house. As part of this process, he has shifted the whole investments team from a generalist model – where an investment professional might be responsible for researching a fund investment, making the commitment and then tracking it afterwards – to a functional model, where the different parts of the process are managed by three different groups.

There’s a research group, run by Sarah Corr, which aggregates external research and synthesises it with portfolio data to inform the house view. There’s the investment management group, headed by Christine Gogan, which monitors the portfolio and feeds information back into the underwriting team. And there’s an underwriting group, led by Scott Jacobsen, which writes the cheques. The three group heads plus Desrochers constitute the investment committee.

This eliminates a potential conflict under the old regime, Corr points out. “An investment professional might do his or her own research and underwriting and portfolio management. So that person would have a long-standing relationship with a manager they were trying to objectively evaluate.”

Desrochers agrees. “There needs to be a separation between the people who monitor and the people who underwrite. It’s often a pain in the derrière for the GP, because they like to build a rapport with one person. But today their relationship is not with one person; it’s with CalPERS.”

It may have seemed like a pain in the derrière for existing staff, too, all of whom were suddenly told that they were being reassigned into different roles. Desrochers admits this process was not an entirely painless one. “Everyone likes to write 50 or 100 million dollar cheques. So if you say to people: ‘Tomorrow your job changes’ … This has been a big cultural change, and some people are not necessarily going to be happy about that.”

But the new structure has been helpful in attracting new staff, according to Gogan. “I think that opportunity to specialise and hone your craft in a sub-set was particularly attractive to a lot of the people who came to join us. One thing that’s really different is that the functional spec has allowed staff to go deeper within a vertical to build expertise.”

It’s certainly true that there are some impressive résumés among CalPERS’ recent recruits. Jacobsen himself, who joined in 2010, has degrees from Harvard and Stanford, plus 10 years’ investment banking experience with UBS and consulting experience at Bain & Co. A flick through the bios of the rest of the team reveals a healthy Ivy League contingent, along with experience at blue-chip financial names like State Street, Morgan Stanley, Pantheon, Neuberger Berman, Deloitte and McKinsey.

All these recruitment efforts might sound like a sure-fire way to increase costs. But according to Desrochers, the cost base has actually come down (which says a lot about how much CalPERS was spending on external consultants).

In addition, it substantially diminishes the likelihood of another pay-to-play incident, as Jacobsen points out. “[It’s] partly about cost-benefit analysis. But it’s also about having a risk-aware culture. By doing all this in-house, we can create more consistency across the platform and reduce our operational risk.”

As well as investing in people, CalPERS is also investing in technology, with a new accounting system intended to simplify portfolio analytics. “We’ll have much more visibility on where the value is being created in the portfolio,” explains Corr. “Right now, for example, we can’t tie cashflows to companies, so it’s hard to separate out EBITDA growth from multiple expansion and so on. When the platform is built out, we’ll have all that info in one place so we can use it to analyse performance.”


Manager costs have also been a big focus under the new regime. At the time he joined, says Desrochers, CalPERS was paying out total fees to fund managers of about $1.2 billion, and more than 50 percent of that went to private equity managers. “There was a big drive to reduce costs,” he admits. “It’s early days, but so far we’ve been very successful.”

This drive had a few interesting consequences for CalPERS’ investment strategy.

The first was that it branched out into opportunistic investing, via a $500 million separate account arrangement (or ‘customised investment account’, as CalPERS calls it) with The Blackstone Group’s Tactical Opportunities Fund, a vehicle that looks at non-private equity investments that target a 15-20 percent return.

This had other benefits too, explains Jacobsen. “It was a combination of focusing on the opportunity set, and also doing it in a way that optimised costs, because we could use our scale as an advantage to get reduced economics. But we also wanted more control over our capital. With all of these customised investment accounts we have the ability to turn it on or off whenever we want.” (This was a lesson learned the hard way in the aftermath of the financial crisis, when CalPERS, like many big LPs, suddenly found itself short of liquidity.)

The second consequence has been a greater focus on co-investment activity, which averages down fees. It’s done three in the last year, and Jacobsen says there’s no shortage of good opportunities coming their way. That’s partly because it’s taking a more systematic approach to sourcing: there’s now a programme in place to call key GPs regularly in order to get a heads-up on potential deals. “We’ve gone from being a reactive programme to being much more proactive, and we’re starting to see the results from that,” says Desrochers.

Jacobsen adds that the new structure allows CalPERS to be much more nimble in terms of how quickly it can analyse the merits of an opportunity and come to a decision. “All of [that] typically takes place within a three-week period, although we did one from start to finish in 10 days. I think some of the GPs we’ve co-invested with have been really impressed by how quickly we can execute and come to a decision.”

Nonetheless, Desrochers insists he will continue to take a fairly conservative approach to co-investment, in recognition of the fact that it’s a different sort of skill-set. “We realise that co-investment is a difficult business and a different business: it’s riskier, and we’re going to lose sometimes. So we wouldn’t bet the farm on a co-investment. I’m pretty defensive about what we do.”

As far as prospective GPs are concerned, there’s an important point here. Most discussion of manager costs tends to focus on headline fees. But for CalPERS today, that’s only part of the picture: it doesn’t actually mind paying full price, as long as it thinks that in return it can get outsized returns, or near-term co-invest opportunities, or even future separate accounts.

“We want to match price to the value being created,” says Jacobsen. “We will continue to invest with top managers on full economics – but we’re also really focused on our separate accounts and co-investment programme.”