Schwarzman: Investors have ‘no place else to go’ but alternatives

Steve Schwarzman, chief executive officer of Blackstone Group, got cocky on the firm’s Oct. 27 third-quarter-earnings call.

He was explaining that institutions hungry for yield in the low-return environment are turning to alternatives to get the kind of returns they need to meet their obligations.

What Schwarzman is describing relates to an increasingly desperate situation especially for state pension systems, which have to meet growing obligations to retirees amid falling returns across asset classes. Many state pension systems are woefully underfunded, even as the number of retirees grows and states fail to make up the shortfall, resulting in what Moody’s estimates will be a $1.75 trillion unfunded liability through fiscal 2017.

“The alternative class is going to continue growing and the reason is, there is safety, high returns and fundamentally no place else to go, and that’s a wonderful position. We’ll be like an army that’s moving forward on all fronts,” Schwarzman said, describing plans for new products.

He mentioned one large institution that is in the process of reducing its number of general partners to 30 from 100. That institution “basically asked us how much money, more or less, could they just give us,” Schwarzman said on the call. He added: “That’s going to be repeated in a variety of different areas.”

Schwarzman didn’t name the institution, but California Public Employees’ Retirement System has stated publicly it is working to reduce the number of manager relationships in its private equity portfolio to around 30 from 100 over the next few years.

So I’m going to guess Schwarzman was talking about CalPERS. Blackstone spokeswoman Christine Anderson would say only: “He did not refer to any LP by name as is our practice.”

Megan White, spokeswoman with CalPERS, declined to comment. White did confirm CalPERS has been working to reduce its number of manager relationships.

It’s no surprise if CalPERS wants to shower money on Blackstone – the system wants to shrink its private equity program to manageable size and work with large managers who have the scale to offer a variety of products and fee breaks. That’s a trend happening across the landscape of large institutions.

Blackstone already represents the system’s largest relationship, with 21 active investments representing net exposure of about $4.6 billion. That accounts for about 12 percent of the system’s private equity program, according to a first-half 2016 private equity report prepared for CalPERS by Pension Consulting Alliance.

And CalPERS needs all the help it can get. It produced an overall 0.61 percent net return for the 12 months that ended June 30, 2016 — far from its 7.5 percent target rate. CalPERS’s private equity program beat its benchmark by earning 1.7 percent, the system said in a statement at the time. Fortune said in July CalPERS has 68 cents for every dollar in liabilities, assuming it earns 7.5 percent a year, which it has failed to do two years in a row.

So perhaps Schwarzman had reason to be cocky – CalPERS indeed appears to be going all-in with his firm. But LPs don’t make investment decisions lightly and partnerships wax and wane with performance and other factors. Maybe Schwarzman didn’t intend to be flippant, but it might be wise not to tempt fate.

Private Equity Editor Chris Witkowsky reflects at home. Photo by Wendy Witkowsky