Inside LAFPP’s specialized PE program

We examine how the Los Angeles pension’s initiative to back diverse and minority-owned PE managers has performed and evolved over more than a decade.

The issue of diversity in venture capital has come to the fore this year in the aftermath of the death of George Floyd and ongoing discussions about racial and gender equality in wider society.

Firms throughout the venture community have said they have zero tolerance for racism of any kind and have pledged to promote inclusion at their firms, as well as foster critical conversations on these issues.

The Institutional Limited Partners Association this week launched an initiative to encourage investors and fund managers to lead by example on diversity, equity and inclusion.

The Diversity in Action initiative aims to help GPs and LPs to take concrete steps to advance diversity, equity and inclusion within their organizations. The ILPA initiative had 46 founding signatories, including venture firms .406 Ventures, ForgePoint Capital and Insight Partners, as well as LPs, including Teacher Retirement System of Texas and CPP Investments, among others.

LAFPP’s commitment strategy

One long-standing investor that knows a lot about encouraging diversity of all types is the Los Angeles Fire and Police Pension System.

The Californian pension has committed more than $620 million to 63 diverse and emerging managers since the inception of its specialized manager program in 2007, pension documents from August show.

For public pensions that are bullish in backing diverse and inclusive managers, it all comes down to the nature of the board that controls the systems, chief investment officer Tom Lopez told affiliate title Private Equity International.

“In the US, lots of board members of the retirement systems had been appointed by local politicians, so there’s some reflection of the local community,” Lopez said.

Other institutions, such as foundations and endowments, tend to be more focused on running themselves rather than trying to improve things in other parts of the world, he added.

Three diverse-led firms that have received commitments from the program are tech and communications-focused Astra Capital Management, venture and growth equity firm Oak HC/FT and Defy Partners, an early-stage VC firm with a female co-founding GP, documents from the pension’s consultant show.

The pension system’s emerging manager program began in 1987, investing in stocks and bonds managers that did not have access to institutional investors because of their size or experience as a firm. It commits to first, second or third-time institutional funds with a stated maximum size of about $500 million.

Specializing

It was in 2007 that LAFPP’s board came up with the idea for a formal program for private equity – the specialized manager program – with an allocation attached to it. The pension hired StepStone Group to run the program, Lopez said.

In 2016, LAFPP extended its manager criteria to include firms owned at the GP level by one or more people who identify as minorities, women, disabled veterans and/or lesbian, gay, bisexual, transgender or queer. It was one of the first pension systems in the US to provide this access to the LGBTQ community, according to its 2016 annual report.

The program also invests in funds targeting companies that offer demographically focused products and services to minorities and/or invest in companies located in Los Angeles or California.

LAFPP, which does not have a yearly allocation for the program, has a soft target of approximately 10 percent of its annual PE commitment pace for specialized managers, according to documents from Portfolio Advisors – the fund of funds manager which also runs its specialized program. For its 2020 program, staff recommended $100 million each to Portfolio Advisors and Fairview Capital Partners to invest, and the board opted to raise this to $150 million each to the fund of funds managers, having decided to put more assets into the program.

Commitment sizes have ranged between $5 million and $15 million. With LAFPP’s assets growing over the years – $25 billion as of August compared with $18.5 billion in mid-2016 – there is more of an emphasis on the plan to grow its exposure to emerging and diverse-owned managers, said Todd Hughes, a managing director at Portfolio Advisors.

LAFPP began investing in PE with a 3 percent target exposure in 1996, committing $18.1 million to the asset class that year. Fast forward to 2020 and the fund has a 12 percent exposure target that stood at 10.28 percent or $2.56 billion of commitments as at end-July, according to pension documents. That figure is set to increase as LAFPP’s board voted in mid-August to boost its target allocation to 14 percent.

Tracking performance

The program has been “very successful,” according to Lopez. Other public pensions that have tried these programs have been disappointed with the results, as the returns of the emerging manager partnerships they invested in were lower than those of the core funds in their portfolios, he adds.

A look at the domestic emerging manager PE program from the California Public Employees’ Retirement System, for example, shows its performance is lower than its core portfolio. Its two funds of funds managed by GCM Grosvenor – 2012 and 2014-vintage program which manage $350 million in total – delivered an 8.5 percent net internal rate of return and 1.2x investment multiple and a 7.7 percent net IRR and 1.1x multiple, respectively, as of March 31. This compares with the since inception net IRR of 10.4 percent and 1.4x net multiple as of end-March this year of its overall PE portfolio.

“Going back to the inception of the specialized PE program in 2007, it’s pretty much tracking the core PE portfolio,” Lopez explained. “Historically, on a quarterly basis, the multiple on investment and the internal rate of return are extraordinarily close to the performance of the core PE portfolio, usually three-tenths of a percent.”

Hughes told PEI LAFPP’s specialized manager PE program, which Portfolio Advisors has been managing since 2010 and which Fairview has co-managed since 2017, has delivered from inception until year end-2019 a net IRR of 11.6 percent and a 1.59x net multiple. The strong returns have “added value” to LAFPP’s long-term assumed rate of return of 7 percent, he added.

“This is a very important area of focus for LAFPP’s board. In general, there is a heightened interest in investing in diversity and inclusion,” says Hughes.

Portfolio Advisors, which also manages the fund’s core PE portfolio, began informally tracking information on the ethnic composition of LAFPP’s GPs in 2015. In 2018 the firm created a modified diversity matrix that they ask all GPs to voluntarily complete. The form breaks down the sponsor’s workforce by occupation, gender identity and ethnic background, and includes disabled and veteran employees. The firm has compiled diversity information on approximately 40-45 private equity funds, according to pension documents.