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Pensions & PE

Why is Calpers doubling down on private equity investments?

Calpers likes private equity. Is that a disaster in the making?

4/1/24 11:51AM

As things stand, public pension funds are not on track to be able to fully pay pensioners when they retire. And they need to do something about it.

Since 2001, the actuarial funded ratio for state and local pensions, which measures the value of a pension’s assets against its projected benefit obligations (PBO), or the present value of future pension liabilities, has declined from 100%+ to ~78%.

In layman’s terms, public pensions don’t have enough assets to cover their expected liabilities.

So, what do you do if your pension is under-funded, such is the case with the California Public Employees’ Retirement System (Calpers)?

Well, option 1 is that you could just increase your discount rate to lower the present value of future liabilities. For an incredibly simple example of how this would work, imagine that you have $80B in assets right now, your calculations show that you’ll owe $400B in 30 years, and your discount rate for these liabilities is a conservative 4.5%, which matches the 10 year treasury yield (it would make sense for pension discount rates to be conservative, but they rarely are!). The current value of those liabilities is $106.8B, and your funding ratio would be 0.75. If expected market conditions were to change in your favor (this happens all the time, actuaries just need to provide a justification), and your discount rate jumped to 5.5%, your PBO would fall to $79.8B, now matching your assets, and you’re essentially covered. Great! Nothing really changed, but the numbers look better now. This is an excellent feat of financial engineering.

(For context, most state and local pensions do use discount rates ~200+ bps higher than the risk-free rate(s) associated with the timing of their expected outflows PBO, meaning that they are probably already understating their true liabilities).

Option 2 is that you could increase your exposure to assets with higher expected returns. From Bloomberg:

The board of the California Public Employees’ Retirement System voted to boost the target allocation for private equity to 17% of its portfolio, up from 13%. It also approved increasing private credit to 8% from 5%. Based on current values, that works out to about $34 billion aimed for private equity and credit, while Calpers plans to pare its exposure to publicly traded stocks and bonds.
The shift reflects confidence that Calpers can ferret out attractive investments even as the fund significantly downgraded the expected 20-year returns from private equity in its latest market survey, citing increased financing costs. The $490 billion pension fund adopted the new asset mix following a mid-cycle review based on updated market assumptions.

For context, Calpers currently boasts a meager 72% funded ratio, and after surveying 15 institutional consultants and asset managers, they believe that private equity will outperform other asset classes, and they are investing their portfolio accordingly.

_Source:_Calpers

My question is this: is private equity actually a good investment moving forward?

Bain & Company noted in their 2024 Private Equity Outlook that while global fundraising is only down 1% from its peak in 2021, global exits have fallen by 66%. Private equity investors (such as Calpers!) are investing more money than they are receiving through contributions, as there is a backlog of PE companies looking for exits.

_{Source: Bain}

In the absence of IPOs and acquisitions, some PE firms have turned to raising new funds, called continuation funds, to buy their own holdings, which, of course, isn’t really an exit. It’s just a firm slapping a new label on the holding company responsible for an investment, which resets the clock on management fees (typically, PE firms make more in management fees in the first 4-6 years of a fund’s life) and, more importantly, allows the firm to capture its carried interest profits from the “transaction.” This is an incredible feat of financial engineering.

So, yes, private equity has outperformed public equities over the last 20 years, but those returns aren’t 1:1 comparisons. The public market determines stock prices. If a stock is undervalued, investors typically bid the price up. If it’s overvalued, investors typically sell it down. Private markets, on the other hand, are inherently illiquid, and PE valuations are quite subjective. Firms use one of three methods: discounted cash flows (DCFs), public peer comparables, and precedent transactions, to determine values. Historically, these valuations were kept in check by exit valuations, but if you can just sell your holdings to yourself at a price you determine, well, that seems problematic.

So Calpers, with its 72% funded ratio assuming an already aggressive discount rate of 6.8%, now wants to reallocate tens of billions of dollars to a private equity sector struggling to sell portfolio companies and distribute capital to investors. This feels like a recipe for disaster, no?

Max Knoblauch4h

Nintendo climbs for third day as China ramps up its memory production

Nintendo shares are climbing on Tuesday, marking the company’s third straight session of gains — something it hasn’t done since early March. The Mario maker’s US-listed ADRs were up about 4% in Tuesday morning trading.

The return of the Switch 2 game bundle appears to have stoked investor optimism in the company’s console sales, while China’s accelerating memory production plans could alleviate some of Nintendo’s pain from the “RAMpocalypse.” For the better part of a year, memory prices have surged as AI demand hoovers up compute power. That’s squeezed video game console makers — and the broader consumer electronics industry.

Tracking the performance of Nintendo ADRs against memory giant Micron helps put this move in perspective. Nintendo is a big memory consumer, and not in the front of the line in terms of securing supply. Micron, obviously, benefits from its offerings being in high demand.

Tuesday’s price action is just a drop in the bucket, and comes as part of a recent stretch where the stock market’s high-flyers are having their wings clipped while beaten-up laggards rally.

In its first-quarter results on Monday, Chinese DRAM producer CXMT said it’s ramping up production and issued bullish guidance. The company is planning an IPO later this year, and it could be China’s biggest of the year.

For Nintendo, more global memory production could see rising costs start to deflate, improving margins in a vital year for its new console.

Jon Keegan5h

Snowflake shares rise after BofA raises price target, predicts strong earnings next week

Snowflake shares jumped after Bank of America Securities analysts raised their price target for the cloud data warehousing company to $205 from $195, with a “buy” rating.

BofA analysts wrote that Snowflake will have a strong quarter because “the robust demand it was seeing heading into this year should continue unabated.” The report called the stock a “a share gainer in the attractive and growing AI business intelligence opportunity.”

Snowflake shares are down about 20% year to date. In November, shares hit a 52-week high of $280.67.

Helena Cheng6h

Standard Chartered to replace “lower-value human capital,” cutting jobs “in favor of the machines”

Standard Chartered is announcing a major “it’s not you, it’s me” corporate makeover with a 15% cut of its administrative roles (roughly 8,000 jobs) by 2030 in favor of automated systems.

“It is not cost-cutting, but it is replacing, in some cases, lower-value human capital with the financial capital and the investment capital that we are putting in,” said CEO Bill Winters.

Congratulations to Standard Chartered employees who survive this culling; obviously, your CEO thinks you’re at least medium-value human capital.

Defending the strategy at a press briefing in Hong Kong, Winters explicitly rejected framing the large layoffs as a standard budget-slashing initiative.

He noted that the bank does not view the transition as an unmitigated loss of staff, but rather “job role reductions in favor of the machines,” which will “accelerate as we go full-bore into AI.”

The operational downsizing aims to boost profitability and increase overall income per employee by 20% over the next two years.

The bank joins a long list of companies that have announced job cuts in concert with plans to lean more into AI. Per CNBC, the subsequent performance of these stocks varies significantly, with some up more than 40% and others down just as much, or worse.

Luke Kawa6h

Hyperliquid Strategies spikes on report that the SEC will soon greenlight an “innovation exemption” for tokenized stocks

Shares of Hyperliquid Strategies are soaring in early trading after Bloomberg reported that the Securities and Exchange Commission is slated to release an “innovation exemption” that formalizes rules around the trading of tokenized stocks.

In what Bloomberg dubbed a “surprise move,” the SEC is slated to permit tokenized stocks (crypto wrappers for traditional shares) even if the public companies don’t consent to their creation.

Hyperliquid Strategies is a digital asset treasury company that holds hype tokens and provides liquidity on the DeFi exchange Hyperliquid.

Tokenized securities offer faster settlement and expanded trading hours, though without the same market depth that typically prevails with traditional exchanges and with a higher potential for price fragmentation.

Per the report, which cites people familiar with the matter, these platforms would need to provide their third-party holders with voting rights and dividends in order to list these tokens. As such, the platforms would effectively be required to hold the underlying securities they’d be offering tokenized access to.

Helena Cheng7h

Home Depot reports Q1 sales beat, reaffirms full-year guidance

Home Depot reversed its initial gains following earnings after a spike in long-term bond yields overshadowed the retailer's solid Q1 results.

Key numbers:

Revenue of $41.77 billion (estimate: $41.50 billion).
Adjusted earnings per share of $3.43 (estimate: $3.42).
Comparable-store sales of 0.6% (estimate: 0.9%).

Comparable sales came in below forecasts, while the company reaffirmed its full-year guidance, expecting annual sales to grow between 2.5% and 4.5%.

“Our first quarter results were in line with our expectations,” said Ted Decker, chair, president, and CEO. “The underlying demand in our business was relatively similar to what we saw throughout fiscal 2025, despite greater consumer uncertainty and housing affordability pressure.”

While the company has served neighborhood handymen for decades, its recent growth is also partially charged by its finalized acquisition of Mingledorff’s, a premier wholesale HVAC distributor operating 42 commercial locations across the southeastern United States. Home Depot said the transaction gave it access to high-volume commercial mechanics and residential trade contractors, expanding its total addressable market to $1.2 trillion.

The company is also using machine learning to automate parts of commercial building work that have traditionally been manual. One example is its Material List Builder AI, which lets contractors upload architectural blueprints or dictate voice notes from a jobsite to generate materials lists.

Investors are continuing to track whether strategic pricing changes and distribution scale can help the business maintain its full-year gross margin target of 33.1%.