As New CIO Reshapes Pension, Calpers Makes $1 Billion Bet on Small Funds

The California Public Employees' Retirement System (CalPERS) is making a $1 billion investment in small private equity firms. CalPERS believes that these firms have the potential to generate higher returns than the largest buyout institutions. This move will also give the pension giant more influence in the private equity industry.
Calpers, the largest public pension fund in the US, will invest $500 million each with TPG Inc. and GCM Grosvenor to help launch funds that invest in private equity firms run by women and minorities, as well as newer firms. This will provide seed funding to these firms and help them grow.
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Calpers Chief Investment Officer Nicole Musicco says that the pension fund's latest investments are not related to affirmative action or politics. Instead, she is hoping that by forging ties with private equity managers while they are still young, Calpers will become one of the first calls made when choice deals arise.
"We're not just looking to diversify our portfolio," she said in an interview. "We're looking to generate alpha in a more thoughtful way, and to leverage partners we can work closely with."
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Since joining Calpers in February 2022, Musicco has been working to reduce the pension fund's reliance on private equity giants and reduce fees over time. Musicco's strategy involves gradually investing more directly in companies, bypassing private equity firms altogether. This approach would save the pension fund billions of dollars in fees and allow it to invest more directly in the companies it supports.
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Calpers is the first major investor in TPG's new Next fund and Grosvenor's new Elevate strategy. According to Calpers, the fund could do more strategic partnerships with managers in other investment areas, and having Calpers as an investor will help "to have a smart friend at the table."
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Musicco has a lot on her plate as she takes over at Calpers. The pension fund has been through a lot of changes in the past decade, and she will need to work to restore its credibility and influence. At the same time, she will need to manage demands from politicians and other local organizations on how state money should be managed.
In 2021, California politicians passed a law requiring the biggest public pensions to report more details on their investments with "emerging or diverse managers." This law will help ensure that public pensions are investing in a diverse range of managers, which can help improve returns and reduce risk.
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Calpers, like other pension funds, has faced a shortfall in recent years. The firm's funded status fell from 81.2% in June 2021 to an estimated 72% a year later. This shortfall was due in part to Calpers' poor investment performance in the latest fiscal year, when the pension fund posted a 6.1% loss. This was its worst investment performance in more than a decade. However, not all of Calpers' investments fared poorly in the latest fiscal year. The pension fund's private equity investments had positive returns of 21.3%.
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The new CIO has made an effort to give staff more power to invest in private assets without permission from the board. While she says the latest investment doesn’t represent a “diversity play,” Musicco has also advocated for the firm to weigh environmental, social and governance concerns across its investments. This move has been welcomed by many employees, who feel that it gives them more autonomy and responsibility in their work.
She's taking a more aggressive approach to new managers than her predecessors.
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Ted Eliopoulos, former CIO of Calpers, embarked on a plan to reduce the number of managers the fund worked with during his tenure 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.
Pension fund managers are under pressure to make retirees' pension checks more secure. They typically demand that money managers have a long history of good performance and the ability to weather investment cycles.
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Pension funds often invest with large, well-known investment managers such as Blackstone Inc. This is because these firms have a proven track record and the ability to handle large sums of money.
According to Jonathan Levin, president of GCM Grosvenor, there are attractive returns to be generated by focusing on a segment of the investment universe that has less capital going to it, such as newer and more diverse managers.
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He said in an interview that the last few years have brought a broader set of investors into the conversation, but there is more work to be done.
In 2020, Calpers began taking steps to add smaller and mid-size managers to its portfolio. Staffers argued that younger, more eager investors would boost 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 changes.
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Emerging managers now account for approximately 2% of Calpers' $50 billion private equity portfolio. This represents a significant increase from previous years, when emerging managers made up a much smaller percentage of the total portfolio. Calpers' commitment to investing in emerging managers is part of its overall strategy of diversifying its investments and seeking out new opportunities for growth.
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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. She noted that while these managers may offer potential benefits, they also come with higher costs. Ultimately, she said, the pension would need to make a decision based on what would best serve its members.
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"I think cost will continue to be an issue for many companies," she said. "However, there are new opportunities for talented managers to make a difference."