Active management will become increasingly important as public equity markets normalize, said Anton Orlich, the California Public Employees’ Retirement System’s newly appointed deputy chief investment officer for private markets.
During a June investment committee meeting, Orlich said the pension fund’s overhauled private equity strategy is designed to keep generating excess returns if the prolonged rally in listed stocks fades. CalPERS has spent the last three and a half years rebuilding its private equity program, which he said has undergone a “fundamental transformation” in culture, strategy, process, portfolio construction, returns and competitive standing.
“What was once last versus major peers is now in first place,” said the deputy CIO.
CalPERS expects the next decade of private equity results to build on the foundation the team has put in place, said Orlich, adding that under the CIO’s total portfolio approach, which launches in a few weeks, the private equity team will seek to continue generating excess returns over passive public equity.
“That active management will become all the more important if public equity markets become challenged, which is very likely given that public markets cannot continue to have high returns year after year.”
Orlich said the revamped strategy, launched in November 2022, has already demonstrated its ability to outperform public markets even during an unusually strong period for listed equities. He pointed out that CalPERS’ private equity portfolio has outperformed public equity markets across one-, three-, five- and 10-year periods, whether measured against its official public equity benchmark or the Russell 2000. He added that the current strategy is driving the bulk of the outperformance over the one- and three-year periods.
A key element of that approach has been expanding the use of co-investments and separately managed accounts. CalPERS has reached its target of directing at least 40% of commitments to co-investments, a strategy Orlich said generates meaningful fee savings while also improving returns through better deal selection. The pension fund estimates that every $1B committed through co-investments saves roughly $400M in management fees over the life of the investments.
Co-investments have enhanced both gross and net returns, said Orlich, because they have produced stronger gross returns through deal selection while carrying lower economics than commingled funds.
The new private equity strategy has also shifted the portfolio away from large buyouts toward areas where the team believes active management can generate more alpha. Since launching the strategy, CalPERS has reduced large buyout exposure to 33% from 46% and increased its combined growth and venture exposure to 38% from 20%, while relaunching its venture program after a decade-long absence.
Orlich told CalPERS Trustees that a disproportionate amount of capital will continue to go toward middle-market buyouts, as well as toward growth and venture, where he said innovation creates some of the most attractive return opportunities.
Environmental, social and governance integration also plays a critical role in the new strategy, said Orlich, noting the fund approaches environmental and human-capital issues through a fiduciary lens. The team is piloting a new system that tracks labor and other ESG controversies across more than 9,000 private equity portfolio companies on a weekly basis.
Still, even with the tool in place, he acknowledged the practical limits of oversight, noting the team cannot “police every single portfolio company.” CalPERS’ private equity portfolio includes roughly 5,000 companies, he said.
The private equity portfolio’s turnaround can also be attributed to a change in strategy and culture, said Orlich. Although a “super majority” of the private equity staff remains in place, he said employee engagement scores have improved significantly over the last three years because the new strategy fosters collaboration and empowers the team to continuously refine the portfolio.
“Four years ago, the PE program needed a turnaround and today by every major measure laid out in the presentation — returns, peer ranking, funded status, team culture — that turnaround has arrived,” said Orlich. “The current strategy is working and, moreover, as the current strategy continues to scale, the impact on the total fund will continue to grow.”
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