CalPERS CIO Nicole Musicco on Bloomberg Wealth

A month ago, Eliyahu Kamisher of the Los Angels Times reported that CalPERS pension fund posts 5.8% gain, helped by stocks and private debt:

CalPERS swung to a 5.8% gain in its latest fiscal year as the stock market rally and private debt buoyed the largest traditional public pension fund in the United States.

The preliminary return for fiscal 2023 reported this week is a sharp turnaround for the California Public Employees’ Retirement System, whose 6.1% loss in fiscal 2022 was its worst showing in more than a decade. The gain left CalPERS holding $462.8 billion, enough to cover 72% of its future obligations, unchanged from a year earlier.

It’s the first full fiscal year since CalPERS ramped up its private equity investments with a $25-billion bet while increasing the use of leverage and allocations to private debt. The results were mixed. Returns for the year that ended June 30 were driven by a 14.1% surge in publicly traded stocks and 6.5% on private debt, as private equity slipped 2.3%, real assets dropped 3.1% and bonds remained flat.

“It really was a tale of two stories,” CalPERS Chief Investment Officer Nicole Musicco said. “The first half of the year we were flat, and then caught up in the second half.”

CalPERS is trying to make up lost ground after being rocked by successive management changes. It has been leaning on alternative assets under Musicco, who was recruited from a Canadian pension fund last year, amid pressure to meet an annual return target of 6.8%. If there’s a shortfall, municipalities across California might have to cut services in order to meet pension obligations.

The preliminary five-year average return now stands at 6.1%, down from 6.7% the previous fiscal year. The 10-year average is 7.1%.

The latest results mirrored a slowdown in private equity markets as higher interest rates ended years of easy deal-making. The loss from private equity for CalPERS followed gains of 3.3% and 44% in preceding years. The fund’s data for private equity, private debt and real assets are reported on a one-quarter lag and were current as of March 31.

Musicco expects a “downward tail wind” to hurt private equity returns when those numbers are updated, but she remained bullish on the asset class.

“There’s such a huge menu of opportunity within private equity,” Musicco said in a call with reporters.

CalPERS Chief Executive Marcie Frost said the pension fund is maintaining its focus “on meeting the long-term retirement promises made to our members and their families.”

The California State Teachers’ Retirement System, the second-largest U.S. pension fund, has yet to release its fiscal 2023 results. This month CalSTRS Chief Investment Officer Christopher Ailman said he expects an “upper-single-digit kind of year” that falls short of its 7% benchmark.

Despite the 2.3% loss in private equity last fiscal year, CalPERS remains committed to the asset class.

In May, Josephine Cumbo of the Financial Times reported the massive pension fund signaled an ‘appetite’ to increase bets on private equity:

Calpers, the biggest US public pension plan, is considering bigger bets on private equity despite growing fears that higher interest rates will curb the industry’s returns.

Chief executive Marcie Frost said that the $442bn-in-assets retirement fund, one of the world’s biggest investors in private equity, will start an extensive review of its holdings in this sector next month, adding that there is “appetite” to increase its allocation.

The review of Calpers’ $52bn private equity portfolio will take place nearly nine months after Nicole Musicco, who started as chief investment officer last year, said a decision to put the pension plan’s private equity programme on hold for a decade between 2009 and 2018 had cost it up to $18bn of returns.

“If we [the Calpers board] had conviction that we could put more money into private equity, the appetite is there to do it from an investor perspective [and] from the investment office’s perspective,” Frost told the Financial Times. “That’ll be part of the asset allocation review.”

Frost’s comments come as many investors worry about returns from the private equity industry, which has sucked in trillions of dollars of assets over the past decade.

The sector is now facing much higher debt financing costs, a deteriorating global economic outlook and concerns about the potential for “stale” valuations lagging those of public markets. Last year the chief investment officer at Danish pension fund ATP compared the private equity industry to a pyramid scheme.

Frost said that there was “a lot of debate” about private equity valuations, but believed the methods used to value Calpers’ portfolio were sound and the fact that private equity valuations were generally only reviewed every quarter was not a major issue for the fund.

“I don’t believe that there’s a problem with the quarter lag on the valuation, it really comes down to the processes that are used [for the valuation],” she said. “Our processes are quite sound . . . we have those done by outside entities.”

Despite the challenges buyouts firms are facing, some investors are increasing their bets on the asset class in a bid to profit from cheaper valuations. Some of the best performing private equity returns were generated in the wake of the dotcom crash and the global financial crisis, according to PitchBook data.

At the start of the 2022/23 financial year, Calpers increased its target allocation for private equity from 8 per cent to 13 per cent. This could rise further if the review gives the green light. Calpers is keen to make new investments into private equity directly, rather than using external managers.

Frost also said the fund is “seeing more deal flow opportunities” in private debt following the collapse of Silicon Valley Bank and other lenders, and that the fund was ready to take more risk to profit from such positions.

“Based on current tightening in the banking industry, there are opportunities that we could pursue,” she said. “We are in a place where we have liquidity, we have a lot of dry powder that we can put to use,” she added. “So we think that as long as we have the appropriate underwriting, this is an opportunity even in a distressed environment.” Her comments come after a turbulent period for the banking sector, with Signature Bank and First Republic in the US also both collapsing and ailing Swiss lender Credit Suisse being taken over by rival UBS.

The Federal Reserve this month warned of a “sharp contraction” in credit. Big private capital firms such as Blackstone, Apollo Global and KKR have been exploring ways to increase their exposure to private credit.

Frost said the fund was prepared for the extra risk that private debt investing could involve.

“You’re not going to get the returns of 6.8 per cent [the scheme’s annual target] long term without taking on some risk,” she said.

Indeed, you're not going to get anywhere near 6.8% without taking some risk, be it in private equity, in private debt or even in venture capital where CalPERS is looking to increase its exposure in the coming months, despite a swoon in the startup market and lackluster performance of late by the fund’s VC portfolio.

But in order for CalPERS to increase its allocation to private equity in an intelligent way, it needs to adopt the Canadian model or some critical elements of it.

Nicole Musicco knows this very well. 

I just finished writing a comment on how BCI's head of private equity, Jim Pittman, is keeping their massive PE portfolio liquid, focused and agile in a difficult environment.

Nicole is doing the exact same thing at CalPERS, ie. selling overvalued fund stakes in the secondaries market to shore up liquidity, building solid relationships with top private equity funds in order to gain access to large co-investment opportunities to reduce fee drag and increase their allocation to that asset class.

Just like their large Canadian counterparts, funds the size of CalPERS and CalSTRS need to have a strong fund and co-investment program in private equity to increase or even maintain a healthy allocation to this important asset class while they lower fees to improve long-term returns.

And don't kid yourself, private equity remains the most important asset class for all global pensions looking to secure long-term return targets.

One area where CalPERS will not be increasing its risk is in China where they're taking a cautious approach.

This week, Nicole Musicco sat down for an exclusive interview with Carlyle co-founder and co-chair David Rubenstein on Bloomberg Wealth to discuss return targets, the pension's push into private equity, and facing political pressure over investment decisions.

I really like this interview because David Rubenstein asks insightful personal and professional questions (he's a natural at interviewing) which Nicole answers sincerely and authentically.

What impresses me is she pivoted from studying physiology to study business, completed two undergrad degrees, did a summer internship at Ontario Teachers',went to work at Salomon, Smith Barney on Wall Street as an investment banker, came back to Canada to complete an MBA at Western University and then spent 16 years at OTPP's private equity team before leaving for a short stint at IMCO (where she headed up private markets) and then settled at RedBird Capital Partners before ultimately accepting the job of CIO at CalPERS.

Nicole told Rubenstein she found the role intellectually challenging and wanted to complete her 5-year mandate to put the fund back on the right track. Ultimately, she wants to head back into private equity when the time is right (she's still young, in her forties).

I chuckled when he asked her what do people say at cocktail parties when she says she's the CIO of CalPERS: "Are you crazy?" (LOL!)

Anyway, take the time to watch this great interview with Nicole Musicco, CIO of the $465 billion California Employees' Retirement System, or CalPERS, the largest public pension in the United States.

She also talks about infrastructure, challenges in office real estate, ESG, Generative AI, and more.

I wouldn't be surprised if Nicole comes back to Canada one day to run one of the Maple Eight. She's an excellent leader who knows what she's talking about and I'm sure she's navigating the political environment in California very skillfully (with the help of Marcie Frost) as she bolsters their private market investments over the long run.