Investors Are Seeking More Support for Private Equity Co-investments

The uptick in outsourced co-investment platforms is part of ‘the next generation of thoughtful portfolio construction.’

By Dietrich Knauth

Pension funds are increasingly seeking outside help with their private equity co-investments, looking for partners that can help them build a more diversified co-investment portfolio, see more deals, and react faster to opportunities.

Pensions typically invest in private equity funds as a limited partner, paying a management fee of two percent of committed capital plus a 20-percent “carried interest” fee on higher profits. Co-investments offer limited partners the chance to invest in a company alongside a private equity firm, but outside of a traditional fund structure, often with no management fee and no carried interest. While LPs like the fee breaks, PE firms can use co-investments as a perk for key investors, or to invest in deals that may be outside the scope of their fund’s mandate, such as getting around a provisions that limits the percentage of a fund that can be invested in a particular company or a particular industry sector.

Despite those benefits, co-investment discussions are “frustrating, and often fruitless,”according to a June 2019 paper by Hamilton Lane. A majority of private equity GPs surveyed by Hamilton Lane said that less than a quarter of LPs that ask for co-investment are actually executing on those opportunities.

Most limited partners, pensions included, don’t have the bandwidth to respond quickly when an opportunity arises, let along evaluate enough deals to build a diversified portfolio of co-investments, according to Richard Hope, a managing director on Hamilton Lane’s global investment team. An LP that can quickly sign off on a deal – or even quickly say “no” – will spare a GP the distraction of trying to scare up extra capital at the same time it is negotiating a co-investment deal, Hope said.

“GPs want certainty of capital,” Hope said. “In a competitive deal market, GPs want to know who’s with them, and how quickly they can respond.”

Despite the challenges, the value of co-investment deals has more than doubled since 2012, reaching $104 billion in 2017, according to a 2018 report by McKinsey. Hamilton Lane attributes much of that growth to dedicated co-investment funds and more bespoke solutions run by institutional managers.

Read the full article, as published by Chief Investment Officer:

Five Questions with Stanford’s Ashby Monk on fee transparency

Stanford University Prof. Ashby Monk advises pensions on innovative approaches to PE. He spoke with Buyouts about the dangers of pension fund complacency toward high PE fees.

You recently took to Twitter to disagree with a pension fund CIO who was happy to spend millions in PE fees to get billions in returns. Why?

In saying “millions to get billions,” you are in effect justifying a high fee to an external partner solely on the basis of the performance delivered. But defining performance in absolute terms like this tells you very little. It doesn’t tell you how much risk they took, it doesn’t tell you the strategy or whether that strategy is commoditized. It doesn’t tell you if you could and should build that strategy internally or find partners that can offer better terms.

Check out the full article, published by PE Hub:

TPG’s Coslet: Few companies are truly worthy of long-term holds

A panel of experts offered feedback on California Public Employees’ Retirement System’s plan to create a long-duration captive private equity fund, saying long-term or permanent investments could add value but would have lower returns than traditional PE.

The $346 billion pension has proposed a new investment model that would create two CalPERS -controlled PE funds, Horizon and Innovation. If approved, the Horizon fund would invest long term in large “core economy” companies, while Innovation would focus on late-stage investments in life sciences, healthcare, and tech.

Experts invited to speak at CalPERS’ January offside board meeting gave mixed feedback on the Horizon proposal.

“One of the things that gets a little lost in this discussion of long-term investing is there aren’t that many companies that you know when you buy them that you’d like to hold them for 20 years,” said TPG’s Jonathan Coslet.

Check out the full article, as published by Buyouts:

CalPERS needs to upgrade its skills to succeed in private equity, CIO says

The $353bn California Public Employees Retirement System (CalPERS) needs to develop new expertise if it’s going to overhaul its private equity strategy, according to CIO Ted Eliopoulos.

CalPERS’ private equity portfolio is currently composed solely of traditional private equity funds run by general partners, and it has become quite good at vetting those partners and the opportunities they offer, Eliopoulos said at the mega fund’s June meeting. But that model won’t be enough to keep CalPERS near its preferred 10% allocation to private equity, which is why CalPERS is pursuing a new strategy that includes direct investments, a commitment to larger strategic partnerships and co-investments with private equity firms, and an increased focus on emerging managers.

The new strategy will require substantial additions to CalPERS’ internal skills and resources, so that it is less reliant on its private equity managers, Eliopoulos said.

“Our private equity program, our team, our systems, our methods are really geared all towards performing this function of selecting an external general partner,” Eliopoulos said. “The [new strategy] really seeks to add to this capacity the ability to select and invest in individual portfolio companies. This is a new domain.”

The board has not made a decision on the new strategy, but board members generally sounded positive when discussing the new model at the meeting. The plan also received an endorsement from University of California professor Ashby Monk, who said that more public pension plans could benefit from thinking outside the box on private equity.

Read the full story: CalPERS needs to upgrade its skills to succeed in private equity, CIO says

Published by Money Management Report/Pageant Media.

Montana explores multi-asset strategies, commits $125m to private markets

The Montana State Investment Board is researching multi-asset strategies to build out a new diversifying strategies, and may also be on the lookout managers in its natural resources and real estate portfolio.

The fund, which manages $18.4bn in assets in several pension funds and state trusts, including $11.4bn in pension assets, also reviewed $125m in private markets commitments at its May 22 meeting.

Diversifying assets is a new asset class for the state, which gave investment staff the go-ahead in February to begin allocating to a target of 0% to 4%. The asset class includes a potentially wide mix of public markets investments that seek to provide downside protection while maintaining liquidity and providing a better return than just holding onto cash. Creating a new asset class was necessary, according to CIO Joe Cullen, to allow the state pension funds to take advantage of multi-asset strategies and other investments that otherwise would not fit within the state’s asset allocation structure.

Montana has started building the asset class with an internally-managed strategy focused on long duration U.S. Treasuries, and currently has an allocation of $26m, or 0.26% of its pension portfolio.

“If interest rates continue to rise meaningfully, we’ll probably add a little bit more that that position, but more meaningful to this asset class of diversifying strategies, [director of public markets] Rande [Muffick] and the public markets team are looking at some of these multi asset class managers,” Cullen said at the May meeting. “We’re looking, we’re not going to say ‘oh by this date we’ll have one’ but we’re going through a process now during the summer that if one comes out of that process, or two, over the summer, then that’s something we’ll bring to you in the fall.”

Read the full story: Montana explores multi-asset strategies, commits $125m to private markets

Published by Money Management Report/Pageant Media.

Institutional appetite drives a rise in PE ‘mega-funds’

As institutional investors try to ramp up or maintain their commitments to private equity without spreading themselves thin on due diligence efforts, their increasingly concentrated investments have helped support a trend toward private equity mega-funds.

Concentration at the top poses some challenges, but investors aren’t fazed: Since 2015, fewer investors have sought to make four or more fund commitments annually and more are gravitating towards making two to three fund commitments, perhaps suggesting an increase in ticket sizes, research firm Preqin found. The increased demand, as well as a need to reinvest capital from older private equity investments, and new players like sovereign wealth funds and wealthy individuals, have pushed dry powder held by private equity fund managers to a record high of $1.09tn as of
March 2018.

Private equity managers with good track records are in high demand, and those managers are increasingly able to find enough capital to scale their efforts to previously-unheard of levels, according Christopher Elvin, head of private equity products at Preqin.

“There looks to be a trend towards mega-funds,” Elvin told MMR. “The private equity industry is seeing huge inflows, but investors are increasingly choosing to sink their capital in the largest funds. LPs (Limited partners) prefer to be involved with fund managers that have been successful in the past – with the expectation that those fund managers will be able to generate large returns in the future – and generally fund
managers don’t tend to raise large funds without building up a track record.”

Read the full story: Institutional appetite drives a rise in PE ‘mega-funds

Published by Money Management Report/Pageant Media.

New York Common files its first cyber risk shareholder proposal

The $209bn New York State Common Retirement Fund filed its first shareholder proposal dealing with cybersecurity, calling on Express Scripts to publicly detail its cyber risk and security efforts.

While the proposal failed to gain the support of a majority of shareholders, the state pension system said that cyber risks will be an increasing concern for shareholders in the future.

“A significant number of shareholders spoke loudly at Express Scripts’ annual meeting supporting our call for the company to publicly detail its cyber risk and actions taken to ensure cyber security,” DiNapoli said in a statement. “Cyber security is one of the most critical issues facing businesses today and breaches can affect millions of people, but Express Scripts has provided shareholders with little reassurance or information on
what actions it has taken to mitigate cyber risk in its operations. Company executives should reassure investors that they have taken solid steps to mitigate the risk of a computer breach.”

The New York fund, which holds a $130m stake in the pharmacy benefits management company, requested that the Express Scripts board annually review and publicly report on its cyber risk, including risks related to outsourced business functions, a description of material cyber incidents, risks related to undetected cyber intrusions, and a description of relevant insurance coverage. The company disclosed in 2008 that a data breach affected the personal and medical information of more than 700,000 customers, and State Comptroller Thomas DiNapoli filed the shareholder proposal shortly after the Equifax data breach exposed the personal information of as many as 145 million Americans.

This is the first time the fund filed a shareholder proposal exclusively dealing with cyber security, spokesman Mark Johnson said. Express Scripts had sought to prevent DiNapoli’s proposal from going to a shareholders’ vote, but the Securities and Exchange Commission rejected the company’s request in March, according to the Comptroller’s Office.

Read the full story: New York Common files its first cyber risk shareholder proposal

Published by Money Management Report/Pageant Media.

Oregon CIO uncomfortable with adding more investment risk

Oregon’s investment chief would not recommend adding any more investment risk to the state’s $100bn portfolio, saying in a recent meeting that investment income alone will have a tough time bridging the state pension’s $22bn unfunded liability.

The Oregon Investment Council, whose pool of assets includes the $76bn Oregon Public Employees’ Retirement Fund, had a special meeting in late April to discuss board governance, policy, and its appetite for investment risk. CIO John Skjervem said at the meeting that he appreciated the desire to maximize risk-adjusted investment returns, but said that investment staff couldn’t simply kick their strategies into higher

“We don’t have another gear to go to,” Skjervem said. “This is as aggressive a portfolio as I feel comfortable managing, and I believe to a person my staff feels the same way.”

Read the full story: Oregon CIO uncomfortable with adding more investment risk

Published by Money Management Report/Pageant Media.

LACERS remains indecisive on private equity

The Los Angeles City Employees’ Retirement System (LACERS) remains indecisive about how best to proceed with its 14% allocation to private equity, with one member of the investment committee suggesting looking for a wider pool of consultants before proceeding with interviews of the three finalists identified after a recent search.

The $17bn fund’s private equity program has been unsettled since July of 2017, when the board blew up an ongoing RFP process and started from scratch. At that time, a board member accused the incumbent consultant – and investment staff’s preferred option for a new contract – of fudging the performance numbers for private equity programs managed on behalf of other pension funds. Other pension fund clients stepped to the consultant’s defense, and the consultant explained its methodology in a later meeting, but the bad blood caused by the incident caused the consultant, Portfolio Advisors, to withdraw from consideration during a rebooted RFP process. Now, LACERS is once again on the verge of making a selection during the rebooted consultant search, and once again, some board members seem dissatisfied with the process.

Read the full story: LACERS remains indecisive on private equity

Published by Money Management Report/Pageant Media.