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Clout with a capital "C"

CalPERS' Richard Hayes runs a multi-billion dollar fund at the nation's largest pension company, and when he speaks, the market listens.

Richard Hayes is sitting on a ton of cash.

As the newly appointed head of private equity investments for the California Public Employees' Retirement System, the 35-year-old Hayes oversees CalPERS' Alternative Investment Management program.

The nation's largest pension fund, with more than $158 billion in assets, has roughly half of the program's $18 billion in committed capital invested. That leaves another $9 billion on the table for future investments--a size that dwarfs even the larger mega-billion-dollar venture funds that have emerged in recent years.

With such a voluminous treasure chest of capital at its disposal, the CalPERS private equity program has managed to keep a steady pace of investments. The Alternative Investment Management program has committed roughly $2 billion to $4 billion annually over the past several years.

Hayes on planning for the long-term
The program currently has 50 percent of its portfolio invested in large growth and restructuring investments, 10 percent to 15 percent in venture capital funds, and the remainder in mezzanine, distressed and early stage investments. As part of its private equity program, CalPERs is investing in such programs as the California Initiative. The California Initiative allowed CalPERS to serve as the sole limited partner in designated venture funds, and the pension fund was allowed to help establish investing criteria.

Hayes, who was named to the post last month, replaces Barry Gonder, who resigned to become a general partner with venture capital firm Grove Street Advisors. CNET recently caught up with Hayes to discuss how CalPERS is putting its billions to use at a time when a number of venture firms and private equity funds are pulling in their horns to deal with the markets downturn, and what investment strategy Hayes brings to the table.

Q: How is CalPERS organized?
There is a chief investment officer, Dan Szente, and four senior investment officers, of which I'm one. There's one for public stocks, one for fixed income, one for real estate and one for alternative investments, which is my focus. We're a five-person team who is ultimately in charge of trying to turn $160 billion into $300 billion.

It's important for our members to remember that CalPERS is a long-term
investor. How does CalPERS determine which of these four areas get what slice of the $160 billion pie?
CalPERS' investment committee has an asset allocation process that they go through every several years. And based on various factors and the goals of the pension fund, they set an asset allocation target for each of the four asset classes. Alternative Investments, for example, has an asset allocation target of 6 percent of the pension fund--with a 2 percent range that would allow it to go up to 8 percent. Even though we have been investing in private equity for 11 or 12 years, the asset allocation is slightly under 6 percent of invested capital.

And within your private equity program, how is it determined which fund, program or company you will invest in?
One of the first things we do as part of our annual planning process is do a top-down strategy analysis of the portfolio and of the state of the financial markets around the world, in the various sub-asset classes, such as seed venture capital, early stage, late stage, buyouts, mezzanines, distressed deals and restructuring deals. And based on the top-down analysis, we try to find the best partners around the world to help us implement the strategies we want to pursue.

And where are your investment priorities for private equity?
Right now, it's a very good time to be pursuing distressed investments, given what has happened in the economy.

How have your private equity returns performed?
The portfolio I helped build is in terrific shape. There will be more of
what we have been doing, for example, being opportunistic over time. It's been very positive. The way you benchmark private equity is you need to look at since inception IRR, or multiples of capital. CalPERS started investing in private equity in 1990 and our since inception return, as of March 30, 2001, is roughly 17 percent. That means that every year, over the last 11 or 12 years, we have earned 17 percent a year on our capital....if we can keep a 15 percent IRR on our portfolio over the next 10 years, literally that will mean billions, if not tens of billions of dollars in profits for CalPERS.

How has this 17 percent return compared with the industry norm for private equity?
The average age of our investments in our portfolio is only 2.3 years old. And, these are 10-year relationships and usually it's during the years 1 through 3 where our partners are drawing down capital and making investments, and they don't even actually start returning capital to us until typically years six through, as the average age of our portfolio gets to mature to 4, 5 or 6 years old over the next several years, our stream of distribution profits. We expect (it) to be billions of dollars a year. Last year, we received back $1.5 billion of investment profits. Long term, the public markets will typically return 8 to 10 percent, private equity will typically return anywhere from 12 to 15 to 20 percent.

In your new role, what changes will you strive for?
The portfolio I helped build is in terrific shape. There will be more of what we have been doing, for example, being opportunistic over time. There's no dramatic shift that we're planning. I feel very lucky in that regard.

When the Internet hoopla was happening, I sometimes felt I was missing
out on some of the excitement and leaving some money on the table. But
now I'm glad I kept my discipline and invested in more blue-chip type of
companies. Considering how CalPERS is affiliated with California--a liberal state--do any nonfinancial considerations enter into your investment decisions?
California investments are part of each asset class at CalPERS and are expected to deliver a return commensurate with similar investments of comparable risk. The CalPERS board considers California investments and all other investments on the sole basis of investment merit. They must be financially comparable to other available investment alternatives. The CalPERS Board judges comparability on a risk-adjusted basis. Under existing policy, CalPERS will accept no less in return and may incur no additional risk or cost of a California-oriented investment. Investments in California may have the ancillary benefit of creating jobs, housing and improvements to the general infrastructure, and equally as important, may serve the broad interests of CalPERS beneficiaries.
The board considers the secondary objective of promoting economic growth and well being of the state and its localities when it is not in conflict with the board's trust duties of loyalty, care, skill, prudence, diligence and diversification. The emphasis is on promoting long-term sustainable economic, industry and business growth, as well as job creation and affordable housing.

CalPERS has been pretty vocal about throwing its weight around with some of its investments. At one point, it tried to get Jerry Sanders tossed as CEO of Advanced Micro Devices and tried to repeal IBM's pension plan, among others. That's a lot of power to wield. Do you plan to be as aggressive in overseeing the companies or private equity that you invest in that aren't VC funds?
Generally, it's the role of our GPs to oversee the investments they make on behalf of the funds we are invested in. CalPERS does not monitor the companies in our GP's portfolios as we do in our public market corporate governance program. Nevertheless, CalPERS believes that good corporate governance is important to long-term performance.

A lot of people got burned in the last 18 months with the market's downturn--including people investing in IRAs managed by so-called pros. Can you give the people whose monies are tied up with CalPERS an ironclad guarantee that you'll make them money?

Hayes on the need to discern the megatrends that matter
It's important for our members to remember that CalPERS is a long-term investor. Recent declines in the market have not jeopardized the payment of retirement benefits and the long-term returns for our portfolio are positive. We have a well-diversified portfolio of assets that have helped offset strong declines in the equity markets. Our members should not let one year's performance undermine a proven long-term investment approach. The equity markets were at high levels and we knew we were in for an overdue correction. This is a natural process, and we have modeled for this in our asset allocation.

CalPERS reputation among the venture capital community was that it was difficult to work with. And, as a result, it was shut out of a lot of venture funds. How would you describe your current relationship with the venture community and how you got it there?
Our board recognized that if we would be a lead partner in private equity, we needed to be a good partner. During my first two years here, we worked with the board and a consulting company on how we could be the partner of choice, streamline our decision making and restructuring the CalPERS approach. The CalPERS today is dramatically different from the one in the early 1990s. And I'm proud we've become the investor of choice.

And how about your personal portfolio? How would you describe your investment strategy?
I have a similar philosophy as the one I use with CalPERS. I'm broadly diversified and fairly conservative. When the Internet hoopla was happening, I sometimes felt I was missing out on some of the excitement and leaving some money on the table. But now I'm glad I kept my discipline and invested in more blue-chip type of companies.