CalPERS's CIO Ready to Ramp Up In-house PE?
I last spoke with Ben Meng in late March and I must say, he's a really smart and nice guy which is exactly how he comes across in this Reuters exchange.
Meng begins this exchange by discussing his background and how he got lucky coming to the US from China where he was studying engineering. He studied transportation at UC Davis to study in the mid-90s and got familiar with tech stocks.
He opened an Etrade account and started buying high-beta tech stocks and found it "easy and exciting" as he started making money through "a stroke of luck". He actually sold his tech stocks before the tech bubble burst ("another stoke of luck") to finance his Masters in financial engineering at Berkeley Haas.
At Haas, he got great theoretical training and was able to network to land a job on Wall Street. Meng worked on Wall Street as a bond trader with Morgan Stanley, then as a hedge fund manager at Barclays Global Investors in San Francisco before joining CalPERS in 2008, overhauling the pension fund to better manage risk in the wake of the financial crash (worked in the asset allocation group).
He came back to Haas to teach risk management, winning a Cheit teaching award in 2014. After a three-year stint in China managing the country's $3 trillion in foreign reserves, he returned to CalPERS to manage its now $380 billion in retirement assets.
Meng discusses the challenge of managing CalPERS's huge portfolio. He said there are a number of challenges:
- CalPERS's assumed rate of return is 7% and when the yield on the 10-year US Treasury note is 1.5%, "where do you earn the additional 5.5% on $400 billion?". Last year, they fell short of that 7% bogey, earning 6.6%, but Meng was quick to state they are "long-term investors and not fixated on a one, two or three-year return."
- CalPERS's funded status is 70% and this limits their options to earn 7% because as he states, if they were 100% funded, he'd have more options available to earn that return. "When you are 70% funded, you need to be mindful of drawdown risk, so that limits our options."
- CalPERS's size is a double-edged word as it "can be an advantage and a disadvantage" and in the current environment, it's a "disadvantage" because "it makes it harder to be nimble and make a difference". He said there are "some smaller niche strategies" that are offering attractive returns but they require a lot of internal resources and "don't move the needle" because you can't scale into them. "Our size limits the strategies we can look at".
Meng praised his predecessor and said while cost savings are important, they have to engage external managers because "they don't mind paying for performance but at the same time they are looking at opportunities to lower costs."
In terms of internal versus external management, Meng said most of the public markets are managed in-house and CalPERS has built a great internal team to manage these public assets in-house (about 80% of total fund).
Then he started talking about private equity, more specifically "Pillar III and Pillar IV" which is their new program that they got a green light earlier this year from the board to "explore the concept".
[Note: Under CalPERS' plan, the first of four private equity pillars would consist of commingled funds, co-investments and separate accounts; a second pillar would hold an emerging manager fund of funds; a third pillar would set up but not own one or more limited liability companies to make late-stage venture capital and growth equity investments in technology, life sciences and health-care companies; and a fourth would set up but not own one or more LLCs to make long-term investments in core economy companies.]
Meng said if you look at the private equity market, "more companies stay private for longer and there has been a lot better wealth creation in private equity market instead of going public and when the market opportunity shifts, you need to shift too" and the second reason is that "private equity is the only asset class that is projected to deliver over 7% over the long run".
He said "we need more private equity and we need it sooner than later." He also said the challenge for CalPERS in private equity is they manage roughly $400 billion and are targeting a 10% allocation to private equity (roughly $40 billion) but they can't even get to an 8% allocation, they are only at 7% right now.
Meng explained that the dispersion of returns in private equity are huge and it's challenging to get access to top-quartile managers in the scale required to reach their 10% target allocation.
To address this, they started a co-investment program and are looking at managed accounts, but the reason they are looking at Pillar III and Pillar IV which are captive to CalPERS is to get to the scale and "they are purposely designed so they have no competition to our existing portfolio." For example "Pillar III is tailored on late stage growth, particularly life sciences, healthcare and nanotechnology and currently we don't have that in our portfolio."
Meng said longevity risk poses a bigger challenge for them as in the most recent study, the life expectancy of their members increased by two years. He said there is a lot going in life sciences and they want to tap into that to put it on their assets.
As far as Pillar IV, the long-term private equity program, he said they are looking at finding private equity professionals with experience who are not chosen to be part of the succession program at the current GP where they are working to be part of this captive structure where they won't have to worry about raising funds, only focus on long-term performance.
Meng was careful stating they haven't found this team yet and this new PE program (encompassing Pillars III and IV) is at "double arm's length" from CalPERS presumably so they can pay these individuals the required compensation but it raises all sorts of transparency and governance issues.
He said the politics at CalPERS isn't frustrating but it is "a constraint" when you compare it to the Canadian model where the governance was laid out at the outset, keeping politics outside the operations of large Canadian public pensions.
In terms of big risks, he said he wonders how much the trade tensions affect business and consumer confidence and how much of it spills over from manufacturing to service sector.
He said they have been taking steps to position the portfolio according to their longer term view and treat geopolitical risks as noise until it impacts their long-term view. They have a long Treasury segment, a long high-yield segment and a long spread segment and "this long Treasury segment" has helped and on the equity side, they have a long risk segment.
In terms of being a Chinese heading America's largest public pension fund, he said he chose to become a US citizen because of "free speech" and he trusts the political system but occasionally he hears negative things about his background but he ignores it (CalPERS is lucky to have him as their CIO and any idiot who feels otherwise should be ignored).
Anyway, take the time to read the full exchange here, it's excellent.
I am a bit surprised at some of the things Ben Meng stated on private equity. Back in June, I wrote a comment on how BlackRock's Canucks -- Mark Wiseman and André Bourbonnais -- are shaking up private equity with their long-term private capital team, known as LTPC.
It sounds like this LTPC is gaining traction with some US funds who like CalPERS, are looking to boost returns, lower costs and gain more control in private equity.
I thought CalPERS would have been far more ahead in terms of Pillar IV and BlackRock's LTPC would be a perfect fit but I'm not so sure that is the route they're taking now that Greg Ruiz is in charge of private equity.
It sounds like they want to find private equity professionals and entice them to manage this program at "double arm's length" from CalPERS but this isn't any easy thing to do even if they manage to find these people, it raises all sorts of governance issues.
It's also worth noting that while private equity is booming (as hedge funds wane), there are reasons to be concerned. Valuations are stretched, there's record dry powder, the industry is preparing for the next downturn, secondaries are no longer selling at a discount, but as long as investors are looking for yield, private equity will be in big demand.
Anyway, I'm sure Greg Ruiz knows what he's doing in private equity and he has his plate full trying to raise the allocation to 10% of the total portfolio. He absolutely needs to do more co-investments, have more separate accounts, and try to ramp up Pillar III and IV as best as possible, and again that's not an easy feat.
Canada's large pensions do a ton of co-investments to the point where co-investments are more important in terms of size than their actual commingled fund investments. This is how they maintain their target allocation to PE (anywhere between 10 to 15%) and reduce the cost of their overall PE portfolio (pay no fees on co-investments, it is considered direct investing).
But as Ben Meng noted, Canada's large pensions pay their employees extremely well to attract and retain talent, maybe not as well as Blackstone, Brookfield, or Goldman but well enough and they have the added benefit of never having to raise funds.
When you are doing co-investments, turnaround time is critical, you need highly qualified employees to analyze large transactions quickly and respond in a timely manner.
Of course, Ben Meng knows all this but as he stated, he is operating in a whole different world at CalPERS, and he has to live with those constraints.
Let me give you a flavor of the politics at CalPERS. SWFI recently reported on how CalPERS board president Henry Jones defeated J.J. Jelincic in a heated race:
CalPERS Board President Henry Jones defeated former CalPERS board member and investment officer J.J. Jelincic (Joseph John Jelincic Jr.) in a race that was 66% to 34% for Jelincic, according to CalPERS data. About 116,000 of the roughly 600,000 CalPERS retirees in the state voted. Jelincic served on the CalPERS board for 8 years and spent 33 years working for the pension system. Henry Jones is a retired Los Angeles school system chief financial officer.There is no question in my mind that J.J. Jelincic is far more qualified than anyone on CalPERS's board to lead that board but he got outspent by Henry Jones and didn't get the union support he needed.
The election was conducted from August 30, 2019 to September 30, 2019 by phone, email, and mail.
Jones will start his new 4-year term, effective January 16, 2020.
According to California campaign finance records, Jones spent roughly US$ 442,000 to retain his seat with support from labor unions and another US$ 50,000 in other contributions, while Jelincic raised approximately US$ 45,000. Jones was backed by SEIU Local 1000, the California Correctional Peace Officers Association, California Professional Firefighters, and other SEIU branches. Jelincic had endorsements from the Retired Public Employees’ Association and California State Retirees.
But J.J. worked at CalPERS real estate (I believe he still does), he is far more experienced than any CalPERS board member in terms of investment knowledge and he always asked the right questions when he was on the board. His presence is sorely missed however I am sure a lot of people on the board and at CalPERS are happy he's gone (because he asked tough questions and demanded good answers).
My point is there shouldn't be any elections to get on CalPERS's board, the state of California should appoint independent, highly qualified board members to CalPERS's board, and leave them alone.
In Canada, highly qualified, independent board members are nominated to sit on the boards of our public pensions and once they are nominated, they can't be replaced by a ruling party (although we have some shenanigans here too and we need to fight hard to maintain the current governance system, the cornerstone of the Canadian model).
Anyways, the governance at US public pensions needs to be revamped but I'm not holding my breath on that because as I keep telling you, there are too many special interests looking to milk US public pension cows, literally sucking them dry.
In other CalPERS news, a judge has postponed a trial in a $1.2 billion lawsuit against CalPERS over an 85 percent price hike to its long-term care insurance policies:
The trial, which had been scheduled to start Oct. 30, has been moved to April 13 to make time for settlement talks, according to court filings.I don't know the details of this case but hiking premiums by 85 percent, that's enough to get public employees pissed off enough to sue you!
The lawsuit, filed in 2013, alleges CalPERS violated contracts when it hiked premiums by 85 percent for about 100,000 public employees after promising stable prices in marketing materials.
CalPERS, the nation’s largest public pension fund, has said it had the authority to increase the rates and did so solely to keep the plans sustainable.
Judge William Highberger warned CalPERS in July it faces serious financial risk in the lawsuit — plaintiffs estimate $1.2 billion — if it goes to trial. The trial is known as Sanchez vs. CalPERS.
Settlement talks were scheduled in September and early this month. Another round is scheduled for November, said plaintiffs’ attorney Michael Bidart. Bidart declined to discuss details.
What else? CalPERS has sold its stock in two private prison companies that operate detention facilities at the southern US border for the federal government:
While the sale pleased advocates who have called for the California Public Employees’ Retirement System to divest from the companies, the $380 pension billion fund isn’t calling it divestment.Call it what you want, it's a divestment and even though I'm not for divestments in general, in certain cases like tobacco and private prisons, I'm ok with it. These investments represent peanuts for CalPERS and in a blue state like California, the headline risk just isn't worth it for CalPERS so good riddance to private prisons!
“It was an investment decision based on what is best for the fund,” CalPERS spokesman Wayne Davis said.
The fund got rid of its $8.8 million worth of holdings in GEO Group and CoreCivic, the nation’s two largest private prison companies, over the last two months as part of broader changes to one of its index funds, Davis said.
Hope you enjoyed this comment, if you have anyhting to add, feel free to contact me at LKolivakis@gmail.com.
Below, CalPERS CEO Marcie Frost joins "Squawk Box" to discuss the factors contributing to investment decisions of the nation's largest public pension fund, which has a current market value of $380 billion. Smart lady, listen to her as she explains the challenges CalPERS faces and what they need to do address these challenges over the long run.
I also embedded Part 1 and Part 2 of CalPERS's Investment Committee which took place last month. These investment committees pack a lot of interesting information I cannot cover in detail here so take the time to watch them.
And Mark Wiseman, BlackRock's global head of active equities, talks about WeWork's failed plan for an IPO and how clients are moving more money to private asset classes. He spoke to Bloomberg's Erik Schatzker at the Capitalize for Kids Event in Toronto, Canada.
By the way, the Managed Funds Association posted a good clip on LinkedIn featuring Blackstone's Tony James discussing less liquid assets which you can watch here:
James rightly notes that alternatives need to be part of the solution for pensions looking to achieve their return target and he's right but it doesn't mean things aren't overvalued right now.
Earlier today, Michael Novogratz, Galaxy Digital CEO and chairman, appeared on CNBC discussing bitcoin and Facebook's libra. He also discussed how private markets have outperformed public markets over the long run because "they're not marked-to-market so they don't have the volatility of public markets."
What Novogratz conveniently omits to say publicly on CNBC is there are inefficiencies in private markets which investors with a long investment horizon (ie. pensions, sovereign wealth funds, etc.) can exploit to their members advantage.
But there is a lot of froth in private markets too, especially when it comes to technology which is why I enjoyed watching Fox News's Tucker Carlson publicly slamming WeWork as a scam last night (see below). Carlson is cocky and often insufferable but sometimes he comes up with gems like this (listen to his comments and the professor he invited to speak on this matter).
As I stated on LinkedIn: "There's too much money with too few brains chasing too many ridiculously overvalued unicorns. Adam Neumann's stone-cold crazy' $1.7 billion golden parachute is appalling, truly despicable. Ray Dalio is right to warn of the next revolution, it’s coming, just look at what is going on in Chile."
And let this be a lesson to all pensions, don't get enamored by the latest unicorn du jour, play it cool, let them first go public and wait a little before investing your members' hard-earned contributions. There are a lot of scams out there, WeWork was just the biggest one.
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