CalPERS: Biggest U.S. pension fund warns on private equity

GENEVA – The booming U.S. private equity market could be heading for a crash as interest rates rise and hedge funds, desperately seeking higher returns, pour money into the sector, the chief investment officer for the biggest pension fund in the United States warned on Wednesday.

"The biggest one (asset bubble) I'm afraid of at the moment is private equity," Mark Anson, CIO for the California Public Employees' Retirement System (CalPERS), told the International Fund Management 2005 conference organised by ICBI.

"The current overhang of leveraged buyouts committed but not invested is $182 billion (end-2003 figure). A lot of money is chasing high yield. Hedge funds are competing with buy-out managers and that convergence scares me," Anson said.

CalPERS has $175 billion in assets and Anson has complete responsibility for all assets in which the pension fund invests, including domestic and international equity, global fixed income, high yield, real estate, corporate governance, currency overlay, securities lending, venture capital, leveraged buyouts and hedge funds.

Anson said the skill sets deployed by hedge funds and buy-out firms are very different, with the funds using their trading abilities to quickly spot and act on mispricing opportunities in markets, whereas private equity companies look to build value long-term in their target investments.

Many private equity deals are also highly leveraged, with buyers borrowing money to magnify returns just as the U.S. interest rate cycle ticks higher with the Federal Reserve raising rates. If too much competing capital pushes down returns in long-term locked-up deals, at the same time as the price of money increases, then there is a danger investments will go sour as investors' calculations are thrown off track.

Hedge funds, which attracted $129 billion in global inflows in 2004, double the previous year, have turned to private equity in the face of falling returns in other markets.

The average returns of funds of hedge funds, the less risky chosen investment route for many institutions, last year was between 4 to 8 percent.

These returns were concentrated in November/December as global equity markets recovered after the U.S. presidential election and were little different from what could have been achieved using index tracker funds at much lower fee levels.

With equity returns in public markets essentially flat for most of 2004 and bond yields near record lows, investors have been flocking to generally higher yielding alternative investments such as hedge funds, private equity, real estate and commodities.

Anson said the best performing sector within CalPERS portfolio over the past five years has been corporate governance investments, in which it now has $3.5 billion.

"Corporate governance has performed extraordinarily well. We started corporate governance five years ago and have had returns in excess of 20 percent despite the performance of the equity markets over that period," he said.

The pension fund builds up concentrated stock positions in companies, or participates in limited partnership pools of capital with other investors to take equity stakes, and implement its corporate governance strategy.

These share positions allow CalPERS access to to the boards of faltering companies and to address issues such as excessive corporate renumeration, lacklustre management, or a failure to listen to shareholders and thereby extract better performance from its investments.

My advice is to ask someone who really knows -- that's not me.

Personally, I'm still afraid interest rates will run up. It hasn't happened yet and for that I am grateful. The economy seems to be growing at an ideal rate (around 4%). This means the Fed won't panic and try to hit the brakes with big rate hikes, which in turn means that rates overall will be 'stable' and rising slowly.

Many fixed rate investments will trade at a discount or a premium depending on its face rate and market rates. In other words, if you had a T-Bond which paid more than current market rates then you could sell it for a premium over its face amount. People would pay 101 dollars for 100 dollar bond if they thought the 100 dollars would earn more interest than 101 dollars invested elsewhere.

The danger (again just in my inexpert and amateur opinion) is that we will see a return of high inflation. It is a real possibility as the Federal government is forced to spend increasing amounts of money in defeating the Islamofacists or some other factor causes the economy to overheat. Even worse would be "stagflation" caused by say a spike in oil prices or another OPEC embargo. Then inflation would be coupled with economic recession ala the Carter years.

Either way, fixed return investments will take a beating. On one hand the return won't keep pace with rising costs and on the other hand it could only be sold at a deep discount (the reverse of the premium reasons)

For now, our President and the Fed are doing a superb job of growing the economy out of the recession which was caused by the Clinton tax hikes. Please consult with a genuine financial adviser.

Here's something related that might interest you:

(HOUSTON, TX) – National Office Partners Limited Partnership (NOP), a joint venture between Hines, the international real estate firm, and the California Public Employees’ Retirement System (CalPERS), announced today the recent sale of 12 buildings from its portfolio.

The total market value for these 12 properties was approximately $2.2 billion.

NOP announced in June its plans to bring 13 properties in its 10 million-square-foot portfolio to market in August 2004 for possible disposition or solicitation of interest in the formation of a joint venture. A bid date was set in September of 2004, and bids were accepted on individual properties as well as on regional sub-portfolios. To date, NOP has disposed of 12 buildings since it began accepting bids four months ago.

NOP’s strategy going forward is to continue to aggressively seek new development and existing-building investment opportunities, with capital commitments from its partners for 2005 that reach a new investment capacity of up to $1.5 billion.

“CalPERS and Hines agreed that it was logical and appropriate to sell a substantial number of properties in 2004 at the pricing levels achieved,” MacEachron explained. “At the same time, like many major institutional investors and pension funds, CalPERS continues to find the returns on a risk-adjusted basis from real estate attractive relative to other asset classes. CalPERS expects to increase substantially its level of capital invested in real estate as its partners, including Hines for NOP, locate and acquire new properties over the next several years.”

National Office Partners was formed in 1998. Following the recent sales of these 12 properties, and including the anticipated acquisition of a new project in Chicago, the investment partnership will own a portfolio of five Class A office assets valued at approximately $650 million. Remaining NOP assets are located in suburban Boston, midtown Atlanta, and the downtown markets in Houston, Chicago and San Francisco. For further information on NOP, refer to www.noplp.com.

CalPERS is the nation’s largest public pension fund with assets totaling $180 billion, of which $13 billion is invested in real estate. The System provides retirement and health benefits to more than one million state and public employees and their families. For further information on CalPERS, visit the System’s Web site at www.calpers.ca.gov.

Hines is a privately owned real estate firm involved in developing, acquiring, leasing and managing real estate, as well as providing extensive international investment management and advisory services. The Hines portfolio of projects completed, underway, acquired and managed for third parties includes more than 700 properties representing over 244 million square feet of office, mixed-use, industrial, hotel, medical, sports facilities and residential properties, as well as large, master-planned communities and land developments. With offices in 69 U.S. cities and 12 foreign countries, and controlled assets valued at approximately $14 billion, Hines is one of the largest real estate organizations in the world. Access www.hines.com for more information.

You can imagine the effect on those of us in the basement when one of our biggest investors decides to dump 2/3 of their portfolio. When CalPERS sneezes we all jump for the Kleenex.

Thanks!

CalPERS sold 101 properties yesterday, this must be part of them .. a drop on the bucket .

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CalPERS shopping centers sell for $2.7B

http://rds.yahoo.com/S=53720272/K=calpers/v=2/SID=e/l=NSR/R=6/SIG=12pvho9tb/EXP=1108613876/*-http%3A//www.bizjournals.com/sacramento/stories/2005/02/14/daily11.html

BizJournals - Feb 14 5:51 PM
A joint venture, largely bankrolled by the California Public Employees' Retirement System (CalPERS), has reached agreement to sell a portfolio of 101 neighborhood and community shopping centers -- including two in Greater Sacramento -- for about $2.74 billion, the sellers said late Monday.

They're like the Red China of Clinton days, they have investments all over the place.

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