Large U.S. pensions ramp PE pacing as some yearn to go direct

Private equity is one of the most popular investment strategies with large public systems in the U.S., based on how many institutions are boosting their target allocations to the asset class.

But several large systems will be looking to do more than passively invest: Many want a piece of direct deal action.

Co-investments are seen as an attractive way to reduce fees and allocate more capital, but access to direct deal flow is not always easy to get.

LPs that take a more active role can be more effective partners for GPs, but they will need resources and governance structures that allow them act decisively to approve and pay for deals, according to Brian Gildea, head of investments at Hamilton Lane.

“Big LPs really want to have more of a voice in terms of something that is more customized to their needs, rather than placing their assets in a blind-pool fund,” Gildea said.

“To the extent that you move direct, you have a team that is making all of these additional decisions — you are sourcing deals, you are deciding which deals to do, and then you have a responsibility to make sure that those companies are run the right way.”

California Public Employees’ Retirement System, with $344 billion in assets, has the most ambitious direct-investing plans among U.S. systems.

CalPERS is working to create two investment vehicles for direct investing. The direct funds would be staffed with non-CalPERS employees, and each would operate like a GP dedicated to managing CalPERS’s commitments in a specific market niche – both late-stage investments in tech, life sciences and health care, and long-term investments in “core economy” established companies.

CalPERS’s board has not yet approved the plan and questions remain about the governance structure, costs, transparency, staffing and effectiveness of the proposal. The plan was originated under former CIO Ted Eliopoulos.

Even without the direct investing funds, CalPERS is working to increase its commitments to PE. The system pledged $5.3 billion to the asset class in the fiscal year ended June 2018 after averaging roughly $3 billion a year average from 2011 to 2017.

CalPERS plans to allocate $6 billion to the asset class for fiscal 2019. It remains far below the $10 billion pacing figure it would need to follow to meet its long-term target, its PE consultant, Meketa, reported last year.

The $10 billion pace wouldn’t, however, be entirely unprecedented for the pension giant. CalPERS committed $14 billion in 2007 and $11 billion in 2008 before scaling back sharply as the financial crisis took its toll, committing just $1 billion in 2009. CalPERS’s PE portfolio was valued at $27.2 billion in November.

CalSTRS

Meanwhile, the second-largest U.S. public pension, the $219 billion California State Teachers’ Retirement System, wants more direct exposure in its $19.3 billion private equity portfolio. CalSTRS has focused more on co-investments than building out a direct model like CalPERS.

CalSTRS’s “Collaborative Model” was introduced in 2018 to effect an “evolution, not a revolution” in its investment approach, pursuing “hybrid strategies” that involve CalSTRS staff working closer with external GPs, leading to lower fees and more control.

“When you’re in a more direct relationship, you get a little more control,” CIO Chris Ailman said in a December explainer video produced by CalSTRS. “So we have a little more involvement in what we buy, which means some level of risk, but we like the idea of being able to really focus the portfolio in areas that we think are attractive.”

The “collaborative model” applies to all private asset classes. For private equity, the plan will mostly mean more co-investments in the next three to four years, according to a report prepared by CalSTRS PE director Margot Wirth in November.

Increased co-investing will also provide CalSTRS staff with valuable experience if it later decides to move into more advanced forms of direct investing like leading or co-leading deals, Wirth wrote.

New York

Compared with their California peers, New York’s pensions have been less open about their intentions. But the $207 billion New York State Common Retirement Fund and $119.9 billion New York State Teachers’ Retirement System in recent strategy documents both emphasized a more direct approach.

NYSTRS wants to bring down its fund-of-funds exposure to 3 percent from 10 percent and increase its exposure to co-investments to 13 percent from 7 percent.

NYS Common, which committed more than $5.92 billion to PE from January to November 2018, also emphasized co-investments with select GPs on improved economic terms. The system committed $178.7 million to 13 equity co-investments between March 2017 and March 2018.

Increasing allocations

Beyond their desire for co-investments, most of the largest public pensions in the U.S. are planning to increase allocations to private equity in 2019.

Some have recently increased their target allocations, including the $73.1 billion State of Michigan Investment Board, which has a 16.5 percent allocation target for 2018 and an 18 percent target allocation for 2019.

State of Wisconsin Investment Board raised its PE and private debt target to 9 percent in December, though it’s already near its new goal. Wisconsin plans to slightly decrease its commitment pace from the $2.3 billion it allocated in 2018.

Many other public investors, though, will continue to make big allocations in 2019, despite being over their policy targets. These include CalSTRS, Florida State Board of Administration, Teacher Retirement System of Texas and Oregon Investment Council.

The $73.6 billion Oregon Public Employees’ Retirement Fund is near the upper limit of its allocation range, with 21.4 percent allocated to PE on a 17.5 percent target, and it plans to discuss strategy for the asset class later in January.

Update: This story was updated to correct a grammatical error.