Orange County boosts PE allocation, targets buyouts

Orange County Employees Retirement System voted to lift its private equity allocation to 10 percent from 8 percent, planning to build a portfolio that focuses more on buyouts than its current exposure.

The $15.8 billion retirement fund is strongly positioned to trade liquidity for higher expected return, although it is probably some ways off before it reaches the 10 percent PE target, CIO Molly Murphy said at OCERS’s Oct. 25 Investment Committee meeting.

Distributions from the $1.43 billion PE portfolio exceeded contributions this past quarter.

“With private equity being a drawdown scenario, it’s going to take us several years to build into that target,” Murphy said. “Probably three or four years.”

Risk mitigation

The new asset allocation will also double OCERS’s allocation to risk-mitigating strategies to 10 percent, pare credit to 11 percent from 13 percent, and cut real assets to 17 percent from 22 percent.

The revised allocation also creates a new asset class for “unique strategies” that don’t fit in other parts of the portfolio, with a zero percent target and a 5 percent upper limit.

Going forward, OCERS will likely seek more buyout opportunities, said Heidi Poon of TorreyCove, the retirement system’s PE consultant.

The current portfolio includes a 40 percent allocation to special situations, 30 percent to venture and growth equity, 26 percent to buyouts, and 4 percent to other PE.

“Because of the significant portion of special situations that you have, it would seem like you are away from target quite a bit,” Poon said at the meeting.

“Those will wind down more quickly as they get paid out, and going forward we will continue to focus on buyout opportunities, so that it better reflects the overall opportunity set.”

At the October meeting OCERS also reported three private-markets commitments worth a total $175 million.

It pledged $75 million to Vista Equity Partners’ Vista Equity Partners Fund VII, $75 million to Monroe Capital’s Monroe Capital Private Credit Fund III, and $25 million to Hellman & Friedman’s Hellman & Friedman Capital Partners IX.

The Vista commitment follows previous investments in tech-focused funds, Murphy said. Since May, OCERS committed $75 million to Thoma Bravo Fund XIII and $10 million to Accel-KKR Growth Capital VII.

“We’ve done a lot of tech this year,” Murphy said. “It’s not by design, necessarily, it’s just that these are ‘best athletes’ for us. It’s also not as much a concern that we’ve done this much tech in this short a period of time because we do have so much diversification through our fund-of-funds.

“These investments don’t really move the needle to the point that we’re getting an overallocation to a particular segment or industry in the marketplace yet.”

For the Hellman & Friedman fund, OCERS had hoped to allocate $75 million but was capped at $25 million by the GP, Murphy said. The commitment marks a new relationship that OCERS hopes will grow over time.

“We will hopefully build an allocation over time as they see us as an investor that they want to cultivate,” Murphy said.

The terms for the Hellman & Friedman vehicle are generally market-standard, but there’s no preferred return, Murphy said.

Instead, there’s a so-called step-down clause that lowers the management fees after the initial investment phase, which should lead to a better overall fee structure for OCERS, Murphy said.

The Monroe fund will pursue direct lending in lower-middle markets, including deals with PE sponsors and direct-sourced lending, Murphy said.

Delegated authority

The board also discussed the limits of delegated authority for investment staff, including the ability to bring on new managers and negotiate terms of new investments.

Murphy discussed her ability to structure agreements with GPs, and different strategies to reduce fees or increase alignment with managers.

For example, Murphy noted that preferred-return standards are in flux, and managers are generally pushing down preferred-return hurdles, but that’s not always something that she would fight them on.

“I will go to the mat for a pref on core, super-core infrastructure,” Murphy said. “That’s only set up to get an 8 percent return out of the gate, so if they miss, I want some security there, and it’s a really long-lived asset, too.

“But most of the things that we’ve brought forth so far in private equity have the potential to return more than 20 percent IRR. I’m not going to walk away from something for the pref when the pref won’t be in play.”

Action Item: Read OCERS’ latest investment newsletter here: https://bit.ly/1kxJG2h