AIM Program Overview

Private equity is the investment in companies that do not trade on a quoted market. Because there is no instantaneous market to trade these investments, private equity is better suited for patient, long-term investors like CalPERS who are willing to wait 10 years or longer to maximize investment returns. Because CalPERS is a long-term investor with a well diversified portfolio, our optimal asset allocation allows for an allocation to the private equity asset class (currently 10 percent of the total Fund).

Performance Comparisons
Historically, private equity has generated superior performance when compared to public equity. Venture Economics, a private equity performance data provider, has created one of the benchmarks for the private equity asset class. However, there is no agreed upon benchmark for the private equity industry as a whole. Below is a comparison of 10-year private and public equity returns.

As of June 30, 2009

Types of Investments

The four major sub-asset classes within private equity are:

• Venture Capital – the investment in companies either in their early-stage, when the capital is used for product development, or later-stage, when companies have started to generate revenue and expect to become profitable in the near future.

• Buyout & Acquisition Financing - the acquisition of a company's assets and operations through the purchase of a controlling equity interest in the company. The transaction usually includes a revised business plan and management structure designed to improve the company's financial performance.

• Expansion Capital - the investment in established companies to provide them with the capital needed to enter new markets or expand operations.

• Mezzanine Debt Financing - the use of subordinated debt and equity to finance a company just prior to an initial public offering (IPO).

Private Equity Market
CalPERS invests in private companies primarily through Limited Partnerships, or funds. These investments are often structured as 10-year legal agreements with a professional investment manager. The manager, or General Partner, is the intermediary between investors with capital and businesses seeking the capital. The General Partner is responsible for the investment decisions and provides guidance to the portfolio companies.

General Partners often specialize by one of the following:

• An industry or economic sector, such as manufacturing, consumer-related, financial services, biotechnology, or communications.

• A sub-asset class such as, venture capital, buyout, expansion capital, or mezzanine debt.

• A specific transaction size.

• A specific geographic region such as Canada, United States, Europe, or Asia.

Investment Process
CalPERS has a detailed and disciplined procedure for selecting General Partners. To understand more about our investment selection process, review the CalPERS Investment Policy on Alternative Investments (PDF, 135 KB).

The basic steps in the investment process are:

1. Partnership Selection
   Private equity investment opportunities are either brought to CalPERS by a General Partner or are actively sourced by our Investment staff. These opportunities are screened for their fit within our current portfolio.
   
   
2. Capital Commitments 
   During a rigorous due diligence process that incorporates the expertise of CalPERS external advisors and investment staff, the merits of a proposal are thoroughly scrutinized. If the evaluation leads to an investment recommendation, CalPERS commits capital to a fund, or Limited Partnership, that will be managed by the General Partner. The General Partner raises additional capital from other accredited investors to create a pooled fund.
   
   
3. Capital Deployment
   As the General Partner selects investments that meet the fund's investment mandate, the money committed to the fund is drawn down.
   
   
4. Generating Liquidity
   Over time, the General Partner implements the business plan for each portfolio company. As the General Partner is able to either exit or partially realize its investment in the portfolio companies, the Limited Partners receive distributions of cash and/or securities from the fund. After the invested capital is returned to the Limited Partners, the profits are shared with the General Partner.

The diagram below illustrates this four-step process.

Private Equity Partner Selection
Our rigorous manager selection process includes an evaluation of many factors including:

• The investment strategy for each fund in which CalPERS may participate.

• The experience and track record of the General Partner in executing the proposed strategy, including the demonstrated ability of the General Partner to add value to the companies in which it invests.

• The fund manager's culture, values, and reputation, based on interviews with the principals and other related parties.

• The alignment of interests between the General Partner and the Limited Partners.

• The attractiveness of the terms and conditions in the contractual agreement between the General Partner and Limited Partners.

Investment Decision
In a Limited Partnership, the General Partner decides which companies the fund will invest in. The General Partner works with the management team of the portfolio company to develop a competitive business strategy and provides input to help manage the companies. The General Partner may implement incentive programs to motivate management to achieve exceptional performance to maximize returns to investors.

Performance-Based Compensation
Compensation is paid to the General Partner in the form of a profit participation, often referred to as carried interest. Profits are usually split between the Limited Partners and the General Partner on an 80 percent Limited Partner-20 percent General Partner ratio. The General Partner draws a management fee, typically between 1 and 2 percent of committed capital, to help support the ongoing management of the firm. When an investment in a portfolio company is realized (often through its sale) the capital originally invested, along with the associated management fees are returned to the Limited Partners before the profits are split. The carried interest is paid to the General Partner after a minimum rate of return to the Limited Partners is achieved. When this compensation structure is used, the financial interests of the General Partner are aligned with those of the Limited Partners, including CalPERS.

Dated: 11-05-2009