Exploring CalPERS and CalSTRS Co-Investment Strategies

As pensions seek to enhance returns, improve funding ratios, and capture a larger share of value creation happening in private markets, many are increasing their private equity allocations. However, this shift comes with challenges, particularly the higher costs associated with private asset management fees and carried interest payments. To mitigate these expenses while maintaining exposure to private equity, pensions are increasingly turning to co-investments

Here we examine how CalSTRS and CalPERS — the two largest US pension funds — have leveraged co-investment programs to achieve significant cost savings and boost the overall profitability of their private equity investments.

CalPERS: Towards a 50:50 Co-Investment Allocation

In a bid to make up for missing out on the exponential growth of private equity from 2008 to 2018 — referred to by former CIO Nicole Musicco as the “lost decade” — CalPERS has been revamping its private markets strategy over the past few years. Last March, the pension increased its private market allocation from 33% to 40%, boosting its private equity allocation from 13% to 17%. This shift is largely driven by the outperformance of private equity in CalPERS’ portfolio, which delivered a 10-year annualized return of 11.4% for the pension as of 2023

Alongside updated private equity allocation targets, CalPERS has also initiated several strategic shifts, including moving away from mega-funds and large buyout managers and increasing exposure to middle-market firms and venture capital. Notably, the pension fund has also chosen to increase its allocation to co-investment opportunities.

In 2022, CalPERS set a target of achieving a 40% co-investment ratio in the 2023 and 2024 vintage years — a goal it has achieved. For example, in 2023, roughly 47% of the capital CalPERS deployed into private equity was directed into low or no-fee capital structures. Moving forward, the pensions’ PE team aims to allocate roughly 50% of its annual private equity allocation budget toward co-investments

These changes are set to yield significant material implications. CalPERS projects that each $1 billion in co-investments saves about $400 million in management fees and carry over the life of the investment. Extrapolating that across its annual PE deployment budget of $15.5 billion and a targeted co-invest ratio of at least 40%, the pension estimates they could save roughly $25 billion across 10 years of commitments.

Additionally, co-investments are also aiding the pension in cash flow management. Anton Orlich, who leads CalPERS’ private equity portfolio, views the increased focus on co-investments as a strategy to mitigate the J-curve effect and create a self-sustaining PE portfolio, where co-investment distributions can be reinvested into future commitments.

However, the plan’s entire PE portfolio, valued at over $72 billion, still has a considerable distance to cover in achieving its co-investment targets. As of December 2023, only 9% of its private equity NAV was allocated in co-investments. Where is the pension focusing its efforts? Co-investments seem to be playing a role in its $100 billion climate solutions investment strategy (a common theme among pensions globally). Between March 2023 and March 2024, CalPERS greenlit over $600 million in climate solutions co-investments

CalSTRS: A Focus on Co-Investments’ Cost Savings

In 2020, former CalSTRS CIO Chris Ailman conducted a ten-year financial plan to examine the rising costs of asset management, particularly private equity partnerships that follow the traditional ‘2 and 20’ fee structure. The takeaways? The costs were unsustainable, and too much profit potential would be lost. With AUM projected to grow to $348 billion in fiscal years 2028 and 2029, annual investment portfolio costs were forecasted to rise to just under $1.8 billion.

Acknowledging the value of private equity exposure, Ailman implemented a ‘collaborative model’ to help ‘bend down the cost curve.’ Inspired by the Canadian pension model, the program seeks to bring investment efforts in-house, collaborate with other institutions to cut costs, and encourage the use of co-investments, joint ventures, SMAs, direct ownership, and revenue sharing. Since its inception in 2017, the model has yielded $2 billion in cost savings.

Today, CalSTRS currently manages 63% of its portfolio in-house, including 45% of its public market holdings and 18% of its private market investments. While private markets make up a smaller share of internally managed assets, the pension’s steady increase in internal management — rising from 16% to 18% YoY — is driving significant cost savings. For example, private equity exhibits the most significant cost savings across asset classes. 

However, as noted by Scott Chan, CalSTRS’ new CIO, establishing a co-investment program has entailed a significant endeavor for the pension. In a recent Markets Watch interview, Chan discussed key elements that have guided CalSTRS’s approach to developing a co-investment program and offered advice for other institutions interested in pursuing such initiatives. Several highlights include:

  • Human Capital: Co-investments pose higher execution risks, requiring a larger workforce and more sophisticated staff. Collaboration with the board to showcase anticipated benefits, gain buy-in, secure appropriate resources, and devise staffing plans is crucial.
  • Diversification: Overloading a co-investment portfolio in one direction increases volatility. Optimal performance requires diversifying co-investments across business units, position sizes, and sectors.
  • GP Partnership: Partnering with top general partners and building strong relationships is crucial for accessing attractive deal flow. Understanding their strengths and weaknesses is equally important to optimize underwriting. Do they have a strong track record in a sector, and are they best positioned to execute a certain value creation strategy?
  • Speed: A large part of CalSTRS’s success in co-investment hinges on its team’s agility in seizing opportunities swiftly — Chan mentions they frequently react to opportunities within a day. This nimble approach keeps GPs satisfied and calling but requires expertise and resources on the private equity team.
  • Operational Excellence: Spending money to hire co-investment resources requires effective monitoring and reporting. Returning to the board to demonstrate the program’s ROI — not only in cost savings but also in returns — goes a long way.

“Every year, we produce our cost report, reporting all the costs across the entire investment division. Then we segmented each of the costs, how much were fees, how much was carry, how much was operational, how much was our own staff, how much were consultants. We slice and dice it in any way the board wants it.”

Scott Chan, CIO of CalSTRS

Chan further emphasized the importance of integrating these elements to foster a strong ecosystem for co-investments in today’s environment, highlighting how elevated interest rates heighten the bar for deal viability and require meticulous scrutiny of cash flow stability.

“If you haven’t built the ecosystem, I would caution people about getting into the co-investment space because, essentially, you need a team to select the right investments fundamentally for your organization. We haven’t been in that market cycle, right? We haven’t been in a cycle where it matters because we’ve been in a low-interest rate cycle where everything works, right? I guess what I’m proposing is that the cycle in front of us most likely won’t be one where everything’s going to work.” 

Scott Chan, CIO of CalSTRS

What’s ahead for CalSTRS’ collaborative model? As the pension looks ahead to its next phase of expansion, exploring private credit co-investments and building out more robust capacity for joint ventures are on the docket. Further, Chan discusses ways to better measure and report on the model’s alpha-creation and risk management benefits is top of mind. 

CalSTRS and CalPERS are among many pensions seeking private equity exposure to capitalize on portfolio flexibility, cost savings, and enhanced returns. As investors pursue these resource-intensive strategies, technology can provide essential infrastructure for managing co-investment exposures, collecting qualitative and quantitative data, and modeling valuations.

Request a demo to learn how Chronograph empowers all institutional investors with best-in-class technology infrastructure to manage co-investing and direct investing programs.

Exploring CalPERS and CalSTRS Co-Investment Strategies

Learn More

The Success of the Canadian Model and Maple 8

Learn More

Subscribe to the Chronograph Pulse

Get updates in your inbox