CalSTRS Cuts Blackstone Back — Is a Power Shift Underway?

The LP-GP power dynamic has always been a tricky thing. It stands to reason that LPs should have superior leverage, because it’s their lucre that feeds the GP beast. But the reality is that GPs – at least the mildly/wildly successful ones – have traditionally run roughshod over their investors. Part of it is because LPs are poorly-networked with one another (therefore reducing the chance for collective action), while another part is that the LP community is ever-growing (making it easier for GPs to say goodbye to a disgruntled LP, because three newbies are waiting in the wings).

This power dynamic did briefly shift earlier this decade – when overcapitalized VC firms were compelled to “hand back” uncalled LP commitments – but that was the only time I’d seen it. Well, until now.

The folks getting short shrift now are mega-buyout firms, which have used LP largesse to raise larger and larger funds over the past several years. Today, however, LPs are using the power of their (shrinking) purses to effect changes in terms of both fund terms and fund sizes. It’s really quite extraordinary, and not something many GPs saw coming.

Yesterday, the WSJ got a lot of buzz for a story about how CalSTRS was only committing $250 million to Blackstone’s sixth fund. This is a devastating drop from the $1.7 billion it committed to Blackstone Capital Partners V, and also mirrors smaller cutbacks at other public pensions. CalPERS, for example, is committing $500 million compared to the $750 million it committed last time (according to multiple sources). The State of Washington has cut back from $400 million to $300 million. And all of them will be getting more favorable fee-splits.

“You can’t overstate how important it is that the most powerful private equity firm in the world is changing its terms. Blackstone wanted its big existing LPs in on its first close, but wasn’t going to get that without making certain concessions,” says a current Blackstone LP who does not work for one of the aforementioned systems. “Blackstone IV had a 60% IRR when it began raising Fund V, so people were anxious to get in. Things are different now.”

Now it’s certainly true that some mega-firms – TPG comes to mind – are doing just fine on the fundraising trail. And it’s also true that certain LPs yesterday told me that this isn’t about LP vs. GP leverage, but rather the macro lack of leverage, the denominator effect (i.e., being over-allocated to PE when the LP’s overall portfolio is shrinking) and a marked drop in distributions.

But I was also told back in 2002 that the first VC fund cut was an anomaly, before it helped spark a movement. I feel the same sort of thing happening here, with LPs finally feeling their oats and standing up to perceived inequities that they once felt powerless to affect. And this is much bigger than Blackstone or CalSTRS — they’re just examples of a trend, not the trend itself. It won’t last long, but it certainly matters in the here and now.
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Two other quick notes on the Blackstone/CalSTRS situation:

1. It should be noted that CalSTRS invested way too much money in Blackstone’s fifth fund. Even for a big system, $1.7 billion is ridiculous. Someone was drinking happy juice.

2. CalSTRS CIO Chris Ailman seemed to partially explain the commitment cut by complaining to WSJ about the intrinsic conflicts of a publicly-traded private equity firm. Felix Salmon follows up on that, saying:

So there’s one big LP who’s very vocal about the fact that he doesn’t like the fact that Blackstone went public. Blackstone can continue to say that its LPs are comfortable with Blackstone’s status as a public company, but they would be much more convincing if they could show it. Have any LPs gone on the record to that effect? And if not, why not?

I agree that it would do Blackstone a world of good to find a notable LP to laud the decision publicly. But it could be tough, as I’ve never heard one laud it privately. I’ve heard negative comments like Ailman’s a bunch, and even more indifference. But actual support? Not yet.