US NEWS: The benchmark LP

Since taking the helm at CalPERS in early 2009, CIO Joseph Dear has made it clear he considers private equity, including real estate, a crucial part of the pension plan’s investment strategy. PERE Magazine, March 2012 issue

When Joseph Dear walked into the California Public Employees’ Retirement System (CalPERS) as its new chief investment officer in March 2009, the US’ largest public pension was chalking up the steepest single-year loss in its history, losing nearly 24 percent of its value. As a result, its allocation targets were wildly off kilter. In addition, in the months following Dear’s appointment, a massive pay-to-play scandal involving ex-pension officials and placement agents erupted, plunging CalPERS into controversy and ultimately resulting in senior resignations, an internal review and a policy overhaul.

Thanks in large part to Dear’s guidance, CalPERS restructured the way it manages private equity relationships, launching an automated system for submitting PPMs. It created a risk management office, established a whistleblower hotline and instituted rigorous travel policies and gift bans. It prohibited firms that serve as investment consultants for the pension from also managing its capital and backed state legislation requiring placement agents to register as lobbyists and forgo performance-based fees.

Under Dear’s leadership, the $224 billion pension system also made some significant changes to its investment strategy, including that for real estate. In February 2011, the CalPERS board adopted a new real estate strategy that focuses primarily on income-producing investments largely located in the US. At the same time, it decided to scale back its exposure to international real estate. Later that summer, CalPERS announced that it had earmarked up to $200 million for a new programme for emerging real estate managers.

Dear has hardly had an easy ride at CalPERS. So it may surprise some that he remains so bullish about the private equity industry’s prospects in coming years. For instance, he dismissed suggestions that only niche or emerging markets strategies can be truly successful in the current climate.

“This is short-term commentary, which is based on what’s happening in the recent past and expected to occur in the near future, and private equity is a long horizon investment if there is one,” Dear said. “Is there an ability demonstrated by private equity managers to produce a higher return reasonably consistently over time? Yes. Has anything fundamentally happened in the capital markets to say that that’s gone away for good? No. Are conditions more difficult or less difficult over time? Sure.”

Dear added: “One of the things we know is that, when it’s very hard to deploy capital, those are often the periods when the returns subsequently are among the best. In fact, when it’s really easy to invest and credit terms are great, that’s when investments come to grief.”

Dear also recognised that Mitt Romney’s presidential bid is bound to result in greater scrutiny of the industry by the popular press. He’s dubious that the industry can do much to alter the focus of an election campaign, but he believes that an organisation like CalPERS, which “has benefited from private equity investment and sees it as an important strategy going forward,” ought to speak out publicly in private equity’s defence.

“Capitalism has fabulous advantages and some downsides – and there are legitimate public policy issues about how to mitigate those downsides,” Dear said. LPs and GPs should participate in such public discourse, he argued, “but we shouldn’t expect to dominate the debate or to have the debate end.”

An excerpt from an interview published in PERE’s sister publication, Private Equity International