On CalPERS' Billion Dollar Push For Diverse Emerging Managers in Private Markets

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Dawn Lim of Bloomberg News reports that Calpers  is making a $1 billion bet on small funds as the new CIO reshapes the pension:

The California Public Employees’ Retirement System is making a $1 billion wager that small private equity firms without the heft of the biggest buyout institutions can boost the pension giant’s returns and clout.

Calpers, the largest public pension fund in the US, will invest $500 million each with TPG Inc. and GCM Grosvenor to help launch funds backing up-and-coming private equity firms, pension officials said. Those funds could take stakes in smaller investment managers and direct money to those run by women and minorities, as well as offer seed funding to newer firms. 

Calpers Chief Investment Officer Nicole Musicco says Calpers’s latest investments aren’t related to affirmative action or politics. Instead, she hopes that by forging ties with private equity managers while they’re young, Calpers will become one of the first calls made when choice deals arise.

“It’s not about a diversity play,” she said in an interview. “It’s about generating alpha in a more thoughtful way, and leveraging partners we will work hand in glove with.” 

Musicco, 48, has made a push for the $449 billion pension fund to invest directly in companies and bypass private equity giants. After joining Calpers in February, Musicco began mapping out a strategy that will gradually curb its reliance on the biggest private equity funds and reduce fees over time.

Calpers is the first major investor in TPG’s new Next fund and Grosvenor’s fledgling Elevate strategy. The pension could do more strategic partnerships with managers in other investment areas, she said, and it will help “to have a smart friend at the table.” 

Major Challenge

Musicco, who spent more than 16 years at the Ontario Teachers’ Pension Plan, faces the challenge of restoring Calpers’s credibility and influence after it cycled through a series of leaders, strategy shifts, and a retreat from private equity in the decade following the financial crisis. At the same time, she has to navigate demands from politicians and other local organizations on how state money should be managed.

California passed a law in 2021 requiring the biggest public pensions to report more details on their investments with “emerging or diverse managers.”

Like other pension funds, Calpers has faced a shortfall — the firm’s funded status fell to an estimated 72% last year from 81.2% in June 2021. Calpers posted a 6.1% loss in the latest fiscal year, marking its worst investment performance in more than a decade. Meanwhile, the pension fund’s private equity investments had positive returns of 21.3%.

The new CIO has made an effort to give staff more power to invest in private assets without permission from the board. Musicco has also advocated for the firm to weigh environmental, social and governance concerns across its investments.

Calpers decided in 2014 to jettison a $4 billion hedge fund portfolio because pension officials thought the investments were too expensive and complex. On Tuesday, Musicco told Bloomberg TV that the pension could reassess its views on hedge funds.

“The hedge fund program at Calpers was shut down prior to my arriving,” she said. “We’re certainly re-looking at that as a strategy.”

A Calpers spokesperson said any hedge fund explorations would be opportunistic, and that the pension has no imminent plans to roll out a formal program or earmark any dedicated allocation for such plays.

Bold Bet

She’s taking a bolder approach on new managers than predecessors.

Former Calpers CIO Ted Eliopoulos embarked on a plan to slash the number of managers the fund worked with during his tenure as CIO from 2014 to 2018. After Ben Meng took over, Calpers scaled back its use of emerging managers in the stock-investing business because various firms’ returns fell short.

Gatekeepers of pension money — under intense pressure to make payouts to retirees more secure — typically demand that money managers have scale and a long history of performance that demonstrates they can weather investment cycles.

As a result, pension funds often go with widely known investment managers such as Blackstone Inc. 

“There are attractive returns to be generated by focusing on a segment of the investment universe that has less capital going to it,” said Jonathan Levin, the president of GCM Grosvenor, referring to newer and more diverse managers.

“The last few years has brought a broader set of investors into the conversation, but there is more work to be done,” he added in an interview.

In 2020, Calpers started laying the groundwork for adding smaller and mid-size managers. Staffers argued that younger, more eager investors would lift returns. Some studied data showing that managers’ earlier and smaller funds outperformed later and larger funds. However, the program’s direction was uncertain at that time amid employee turnover and leadership shuffles.

Emerging managers now make up about 2% of Calpers’s $50 billion private equity portfolio.

In a November discussion, Calpers board member Betty Yee cautioned that the pension would have to weigh performance and costs when thinking about diverse and emerging managers.

“Cost is still going to continue to be an issue, track record will continue to be an issue,” she said. “But that’s not to say we don’t cultivate talent because I do think there are new opportunities out there for bringing in these managers.”

Grace Chung of Institutional Investor also reports CalPERS Pledges $1 billion to fund ‘new generation’ of talent:

The California Public Employees Retirement System is partnering with GCM Grosvenor and TPG to invest in young, diverse, and emerging private market investors.

Through Grosvenor’s Elevate strategy, CalPERS will commit $500 million for seed investments in small, emerging, and diverse private equity firms to help fund and scale their growth.

“This capital addresses an important market opportunity and will ensure talented investors have the ability to launch their own firms and deliver for their clients,” stated Michael Sacks, chairman and CEO of GCM Grosvenor Elevate, in a press release.

An additional $500 million will be committed to the TPG Next Fund to identify and support the “next generation” of private market investors in getting better access to capital, resources, and strategy expertise.

The Next Fund will focus on women, ethnic minorities, the LGBT community, and military veterans, which TPG sees as the fastest-growing undercapitalized groups in the U.S.

“Our hope is that Next can help these diverse managers and the diverse communities that they’re connected to access more capital and bring our industry in line with demographic trends,” Pamela Pavkov, partner and head of TPG NEXT, told Institutional Investor. “We’re foremost focused on identifying investors who have a comparative advantage with respect to sourcing new opportunities, executing investments, and building successful businesses, both at the GP level as well as the portfolio company level.”

CalPERS recently upped its allocation to private investments, which the pension fund views as “an important component of achieving the returns needed to fulfill the retirement promises made to more than 2 million members,“ according to the release. Allocations to private equity — which CalPERS highlighted as the highest performing asset class in its portfolio — were increased from 8 to 13 percent for the 2022-2023 fiscal year.

“CalPERS is committed to giving access and opportunity to new and innovative talent in the investment industry,” CalPERS chief investment officer Nicole Musicco said in the release. “We want to create and nurture an ecosystem that will serve as a catalyst to seed the next generation of diverse talent and foster different ways of seeing and solving problems.”

Citing research from the National Association of Investment Companies, the pension fund noted that diverse private equity managers consistently outperformed their peers, with higher net internal rate of returns than the Burgiss Median Quartile in 83 percent of the vintage years analyzed between 1998 and 2020.

Last year, CalPERS hosted its second Pathways for Women Conference in California, where three of the pension fund’s female leaders implored money managers to appoint more women to executive positions. The CalPERS executives included Musicco, CEO Marcie Frost, and board president Theresa Taylor.

CalPERS issued a press release on how it's committing $1 billion to fund investor entrepreneurship and innovation in the investment industry:

SACRAMENTO, Calif. – CalPERS today announced a $1 billion commitment aimed at identifying and supporting the next generation of investor entrepreneurs in the private markets.

CalPERS will partner with two of its long-standing asset managers, TPG and GCM Grosvenor, with each firm receiving a $500 million allocation from the pension fund.

CalPERS has been investing in newly established teams and partnerships in the investment industry for more than 30 years. This dedication to fostering entrepreneurship, diverse perspectives, and innovation has allowed CalPERS to identify opportunities in the global markets that might otherwise be overlooked, while simultaneously generating returns for the pension fund.

“CalPERS is committed to giving access and opportunity to new and innovative talent in the investment industry,” said CalPERS Chief Investment Officer Nicole Musicco. “We want to create and nurture an ecosystem that will serve as a catalyst to seed the next generation of diverse talent and foster different ways of seeing and solving problems.”

“We welcome and encourage other global allocators to join us in this effort and reimagine the traditional and structural dynamics in the markets.”

TPG, through its TPG NEXT fund, the firm’s strategy dedicated to investing in diverse alternative asset managers, and GCM Grosvenor, through its Elevate strategy, which is focused on making catalytic seed investments in small, emerging, and diverse private equity firm founders, will use their long-standing expertise and reputation to identify and cultivate the next generation of investors. Identified investment managers will gain access to the capital, resources, and expertise they need to mitigate business risks and prudently scale their firms in a competitive marketplace.

“We launched TPG NEXT to empower principal talent underrepresented in alternative assets to become next generation industry leaders,” said Jon Winkelried, CEO of TPG. “CalPERS’ announcement today and its anchor commitment to the inaugural TPG NEXT fund is an important step in mobilizing change in our industry. Together, we will bring financial and operational capital support to diverse-led firms, accelerating their growth and success and demonstrating their ability to generate competitive returns.”

“We are excited to work with CalPERS and other global allocators to elevate the next generation of private markets investment talent,” said Michael Sacks, Chairman and CEO of GCM Grosvenor. “This capital addresses an important market opportunity and will ensure talented investors have the ability to launch their own firms and deliver for their clients.”

This partnership also aligns with CalPERS’ expansion into the private markets. The CalPERS Board recently increased its allocation to private investments as an important component of achieving the returns needed to fulfill the retirement promises made to more than 2 million members.

Private Equity is the highest performing asset class in the CalPERS portfolio and its allocation was increased from 8% to 13% starting with the 2022-23 fiscal year.

Additionally, recent research from the National Association of Investment Companies indicates diverse private equity managers have consistently outperformed their peers. Diverse PE funds represented by the NAIC Private Equity Index produced higher net IRRs than the Burgiss Median Quartile in 83% of vintage years studied from 1998 to 2020.

The CalPERS initiative is part of a larger effort underway, including the development of a start-up investors manual and a June 2023 industry event connecting global allocators with investor entrepreneurs.

About CalPERS

For more than eight decades, CalPERS has built retirement and health security for state, school, and public agency members who invest their lifework in public service. Our pension fund serves more than 2 million members in the CalPERS retirement system and administers benefits for more than 1.5 million members and their families in our health program, making us the largest defined-benefit public pension in the U.S. CalPERS' total fund market value currently stands at approximately $449 billion. For more information, visit www.calpers.ca.gov.

About TPG

TPG (Nasdaq: TPG) is a leading global alternative asset management firm founded in San Francisco in 1992 with $135 billion of assets under management and investment and operational teams in 12 offices globally. TPG invests across five multi-product platforms: Capital, Growth, Impact, Real Estate, and Market Solutions and our unique strategy is driven by collaboration, innovation, and inclusion. Our teams combine deep product and sector experience with broad capabilities and expertise to develop differentiated insights and add value for our fund investors, portfolio companies, management teams, and communities. For more information, visit www.tpg.com or @TPG on Twitter.

About GCM Grosvenor

GCM Grosvenor (Nasdaq: GCMG) is a global alternative asset management solutions provider with approximately $73 billion in assets under management across private equity, infrastructure, real estate, credit, and absolute return investment strategies. The firm has specialized in alternatives for more than 50 years and is dedicated to delivering value for clients by leveraging its cross-asset class and flexible investment platform.

GCM Grosvenor’s experienced team of approximately 530 professionals serves a global client base of institutional and high net worth investors. The firm is headquartered in Chicago, with offices in New York, Toronto, London, Frankfurt, Tokyo, Hong Kong, and Seoul. For more information, visit: www.gcmgrosvenor.com.

Alright, it's Wednesday, hump day and I am going to try to keep it short and sweet today.

First, I did reach out to Nicole Musicco earlier today to discuss this press release but didn't hear back from her.

Typically, CalPERS Communications people contact me when a big announcement is taking place.

Now, I know $1 billion is a big amount to invest in emerging managers but to be brutally honest, this news is a bit of a yawner and disappointing, much like the Golden Globe awards show last night (except for Eddie Murphy, his acceptance speech cracked me up!).

Let me explain.

I'm all for diversity at the Emmys and in the financial and corporate world. 

Any company that doesn't have proper representation at the C-suite, board and all other levels is setting itself up for long-term failure.

The same goes for private equity.

I don't care if you're a PE giant like Apollo, Blackstone, Carlyle, KKR or whoever, if you don't have proper representation and diversity, you're not going to add meaningful value-add to the companies you're taking over and restructuring. 

Now, it's true that certain minority groups are not properly represented in the financial and PE world and gaining access to capital is next to impossible for these groups.

So, it is nice to see CalPERS working with TPG and GCM Grosvenor, with each firm receiving a $500 million allocation from the pension fund to fund new entrepreneurs from disadvantaged groups.

I have nothing against this but the optics do look a lot like pandering to "woke culture" and like a diversity political play even if CIO Nicole Musicco denied it: 

“It’s not about a diversity play,” she said in an interview. “It’s about generating alpha in a more thoughtful way, and leveraging partners we will work hand in glove with.”
More importantly, and this is what I worry about, is the timing of this announcement.

I'm convinced the US is headed for a deep and prolonged recession, even wrote my thoughts out in painful details in my Outlook 2023, so starting this initiative now is risky even if TPG and GCM Grosvenor will be allocating the capital and making sure it is given to entrepreneurs who can generate the requisite returns.

I'm just skeptical. Even during the best of times, seeding emerging managers -- be it long only equities, hedge funds or private equity funds -- is risky business.

You need an experienced internal team or to farm it out to an experienced fund of funds managers with an extensive network.

No doubt, TPG and GCM Grosvenor are experienced investors who will be able to identify small, and are well placed to support the next generation of investor entrepreneurs in the private markets.

In a way, since this is private equity and  the lifespan of funds is typically 3 to 4 years, maybe now is the right time to fund these emerging entrepreneurs who should be able to capitalize on significant market dislocations in the next couple of years.

The other well-known advantages of seeding emerging managers is you can negotiate lower fees and take an equity stake in the management company which can become very valuable if the fund becomes very successful over time.

Still, remember, even in the best of times, seeding emerging managers no matter what background they have is risky business and not straightforward.

This brings me to my other point.

There is political interference at US state pensions.

The Bloomberg article states California passed a law in 2021 requiring the biggest public pensions to report more details on their investments with “emerging or diverse managers.”

In my humble opinion, this is a recipe for disaster.

The Canadian pension model which Nicole Musicco knows all too well as she worked for many years at OTPP separates government from pension administration and investments.

Governments are made up of politicians who have one goal in mind, to get reelected.

They pander to their base and pander and pander and when they mix politics with public pensions, it's always a terrible idea, be it left-wing or right-wing policies (like 'anti-woke' DeSantis meddling in Florida's public pensions).

It always ends up bad.

US politicians from all sides of the political spectrum love polarizing politics, but when it comes to public pensions, it should be made constitutionally illegal to meddle in any of them.

Unfortunately, US public pensions are not governed as well as Canada's large public pensions and that has cost them serious returns over the long run because they simply cannot do what Canada's large public pensions are doing, get the compensation and governance right to attract and retain qualified staff to internalize operations as much as possible.

Nicole Musicco is trying to change this at CalPERS but big changes don't come quickly to these giant funds, she is taking incremental steps and picking her battles wisely.

But when it comes to laws, she has to comply.

Here, she was smart enough to engage the help of TPG and GCM Grosvenor to help her and to make sure the focus remains on generating returns.

Remember, emerging managers now make up about 2% of CalPERS’s $50 billion private equity portfolio, but they are trying to grow that portfolio from 8% of total assets to 13% of total assets.

That is no easy feat, especially in this environment where private equity and other private markets, including private debt, are in for a lot tougher times ahead as a deep and protracted recession lies ahead.

Since 2008, they had it easy, but this time is different, it's going to be much worse than past recessions.

I am not stating this because I get a kick out of recessions and like watching people lose their jobs.

Far from it, I worry a lot about rising inequality and social upheavals that come with economic hard times.

But with every central bank around the world aggressively hiking rates into a slowdown, it would be highly irresponsible and downright dangerous for any pension fund manager to dismiss the real possibility of a looming recession ahead, even if it's the most anticipated recession ever.

Sometimes the bears have it right. And yes, sometimes economists know what they're talking about.

As my former boss now Senator Clement Gignac once told us when I was working as an economist at the National Bank in 1999-2000: "Most of the times nobody pays attention to economists, they want to hear stocks analysts pump stocks. In a bear market, everyone wants to hear from economists to know when it ends."

CalPERS' CIO Nicole Musicco knows all this.

She's a very smart and experienced pension fund manager who has seen a few cycles.

But like Ben Meng and Ted Eliopoulos who preceded her, she isn't God and has to work with the political and other constraints that are imposed on her from CalPERS and California's lawmakers.

And unlike her predecessors, she isn't going to escape a deep and protracted recession which is going to make her job that much tougher and to be honest, a lot more interesting if she and her team map out the right strategy and use the coming crisis to make the best long-term investments across public and private markets.

She also can't do much to lower the pension plan's large funded gap which is likely to grow worse in the next five years. 

On that point, apart from private equity which receives all the attention at CalPERS, I did note this from the Bloomberg article above:

Calpers decided in 2014 to jettison a $4 billion hedge fund portfolio because pension officials thought the investments were too expensive and complex. On Tuesday, Musicco told Bloomberg TV that the pension could reassess its views on hedge funds.

“The hedge fund program at Calpers was shut down prior to my arriving,” she said. “We’re certainly re-looking at that as a strategy.”

I think it's time for CalPERS to restart this hedge fund portfolio focusing on ramping up liquid scalable alpha.

That means focus on global macro funds and CTAs at first, and multi-strategy funds, then start adding some Long/Short Equity funds and other alpha funds.

Nicole used to work at OTPP which has extensive experience investing in hedge funds and she can easily talk to Gillian Brown who leads the Capital Markets group there (great lady, really nice and super smart).

She can also get in touch with Daniel MacDonald a former senior portfolio manager of OTPP's hedge fund group who is now in San Diego acting as Head of Advisory and Pensions at Middlemark Partners. 

Daniel was always one of my favorite hedge fund analysts, he really knows his stuff and is super nice too.

Having allocated to top directional funds while at CDPQ in 2000, and managing a portfolio of almost half a billion dollars, I too know a thing or two about hedge funds.

I was the reason CDPQ was the first to invest in Bridgewater among Canada's large pensions (I told Ron Mock about them).

I've met top hedge fund managers like Viking Global's Andreas Halvorsen (great fund manager), Ray Dalio and others.

I actually met Ray Dalio back in 2004 with Gordon Fyfe and he got annoyed with me when I was pressing him on the housing crisis, looming deleveraging and deflation in the US. 

"What's your track record?," Ray asked me. 

Gordon got a kick out of that meeting, kept teasing me all the way back to Montreal.

I was annoyed with Ray but he was right to bitch-slap me, so to speak, I was young and cocky.

Anyway, now is the best time to focus on liquid scalable alpha.

Bridgewater, Brevan Howard, Rokos Capital Management (think Chris Rokos is awesome and not because he's a Cypriot Greek), Citadel, Millenium, Point72, and many other top funds I track every quarter need to be approached. 

The problem? Good luck getting capacity even if you're CalPERS.

This is why I think it may make more sense for CalPERS to start an emerging hedge fund manager program and do this properly, using a managed account and hiring experienced people to oversee this program.

Again, Nicole can reach out to me for details or talk to Daniel and Gillian for advice.

But make no mistake, the name of the game over the next two years will be scalable liquid alternatives, not illiquid ones which are more long-term plays.

And I do mean SCALABLE or else don't bother, it will not move the needle at all.

Alright, let me wrap it up there, I've rambled on long enough.

Below, Calpers Chief Investment Officer Nicole Musicco discusses the pension fund's investments with TPG Inc. and GCM Grosvenor aimed at launching funds to back up-and-coming private equity firms. She speaks on "Bloomberg Markets."

Unfortunately, I cannot embed this clip below but you can watch it here. 

Listen carefully to Nicole, she outlines her thoughts very nicely.

Also, earlier today, Marcie Frost, CEO of CalPERS, joined CNBC 'Squawk Box' to discuss her response to the lawmakers who sent a letter to the firm warning of antitrust concerns, the battle over ESG investing, and more.This I was able to embed below because it's on YouTube.

Please take the time to listen to Nicole and Marcie.

And lastly, Graeme O'Neil takes a look at Eddie Murphy making fun of Will Smith during his acceptance speech of the Cecil B. DeMille Award at the 2023 Golden Globes. LOL!!!

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