Experienced CEO and founder of How Women Lead, venture capitalist and sought-after speaker on female entrepreneurship.
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Pension funds had about $40 trillion in assets under management in 2021. Yet, some may have concerns about how these funds are allocated due to poor returns on private equity allocations. In 2022, pension plan returns on average saw a loss of 6.14%, according to Equable Institute’s year-end update for its annual pension report. This can result in a loss of funds for retirees planning on shorter-term horizons. Last year, Pitchbook called these returns a “major threat” to plans’ ability to pay retirees in 2023.
In a Financial Times article (paywall), Anton Orlich, managing investment director for private equity at California Public Employees’ Retirement System (CalPERS), said, “If you look at the highest performing private equity programmes, many of those have extremely high proportions of their private equity portfolio in venture.” Orlich described the period between 2009 and 2018 as a “lost decade” for CalPERS, indicating that he believed the retirement benefit administrator missed out on potential private equity returns. CalPERS is planning to expand its venture capital allocation, the Financial Times also said.
Being a venture capitalist who focuses on investing in women founders, how pension funds are investing is something I’m paying attention to. I believe that if pension funds are looking to create better returns for pensioners by investing in ventures, there are lessons they could learn from emerging managers and the larger venture capital space.
Why emerging managers?
Emerging managers are often considered riskier; however, Cambridge Associates reported in 2019 that more than 70% of the highest-performing funds between 2004 and 2016 were new and developing funds. I define “emerging managers” as a general partner who is raising a first through fifth institutional fund and anyone who comes from an underrepresented general partner background.
Why are emerging managers capable of driving high returns on investments? They tend to invest in earlier-stage companies, where there is high growth potential. Diverse leadership in emerging managers can also have a positive impact. Companies led by underrepresented founders have the potential to outperform their counterparts if given access to the same level of funding, according to research by McKinsey. Startups founded or cofounded by women have been found to generate 10% more cumulative revenue over a five-year period than other startups, according to a 2018 article by Boston Consulting Group. So, prioritizing diversity can be beneficial, and the representation of emerging managers may be a part of the strategy.
Some pension plans are already prioritizing emerging managers and diversity. The California State Teachers' Retirement System (CalSTRS) is one example; it has had its emerging manager program in place since 2005 with a primary goal being to partner with diverse investment managers, according to Venture Capital Journal (registration required). In 2023, CalSTRS launched a partnership with Sapphire Partners "to manage its new emerging manager VC investments," Fortune reported.
What lessons can pension funds learn?
From my perspective, pension funds have an opportunity to support companies built by diverse founders, including women and women of color, at scale. I believe this could allow funds to enrich the communities where pensioners live.
I see CalPERS’ move to increase its investment in venture capital as an encouraging sign. Now, there’s a need to lower the barriers for more funds looking to invest in scalable, high-tech and venture-backed companies run by diverse founders. This is where pension funds may find potential for returns and collecting money that I believe they have historically left sitting on the table.
Leaving money on the table isn’t unique to pension funds. VCs have often left money on the table by failing to understand emerging markets or invest in companies with diverse founders. Just take a look at the Grosvenor 2023 report, which shows that of its investments, diverse managers brought in the highest net internal rate of return at 18.3%. Or, look at Morgan Stanley, which found a "trillion-dollar blindspot" that could be addressed by prioritizing investments in women and multicultural founders.
I believe who is making decisions is clearly the most significant factor in performance and diversity. I am seeing some change in the venture space, and pension funds can learn from VCs leading the way. An important step is for pension funds to hire, train and promote women and people from underrepresented groups into decision-making positions.
I also suggest reevaluating risk metrics and ensuring that any consultants chosen have both a track record of investing and a bias-reduction strategy that ensures they are managing change so that women and people of color can get a fair shot. VCs learned a hard lesson when research showed there was gender bias in the questions investors asked men vs. women founders. Pension funds have an opportunity to learn from that. What questions are you asking fund managers, and can you learn from the studies showing the promotion bias for men? As we have seen above, investing in women and people from multicultural backgrounds can be valuable, so how is that showing up in the calculations?
In short, with pension funds underallocating to private equity, I believe now may be a great time to assess new funds and make connections with diverse general partners. Understand who you invest in. It makes a difference. There is money being left on the table, and pension funds are missing it.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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