Limited Partner Notes –

Review Could Prompt Changes at CalPERS

The California Public Employees’ Retirement System (CalPERS) is undergoing a strategic review of its Alternative Investment Management program, with final results and recommendations expected sometime this fall.

Strategic reviews of institutional investment programs are hardly uncommon, but CalPERS holds a special place as the world’s second-largest private equity investor. It managed about $21.4 billion of active commitments to 412 different funds as of Sept. 30, 2004, and is a top client for such consultancies as Grove Street Advisors, Hamilton Lane, LP Capital Advisors and Pacific Corporate Group.

Five years ago, CalPERS retained McKinsey & Co. to conduct an investor review. It still ceded dominant buy-side presence to Ivy League endowments and private foundations. But McKinsey recommended that CalPERS dramatically increase its exposure and investment breadth, including a heralded $500 million program for biotech-focused venture capital funds. Looking back, one private equity market analyst says that the McKinsey report “helped turn CalPERS into the 800-pound gorilla” that it is today.

It is unknown if the new report will be as momentous, largely because its ongoing findings are being kept close to the vest. Donn Cox, a managing director with LP Capital Advisors and a longtime consultant to CalPERS, says: “This seems like a refresh of what [CalPERS] did with McKinsey, but they’ve been very closed-lipped about it. We haven’t been privy to what they’re thinking.”

What is known is that the review will not be completed on time. The minutes from a February CalPERS Investment Committee meeting say that Portland, Ore.-based Pension Consulting Alliance (PCA) had been retained to conduct the review, with final results and non-binding recommendations to be presented by either June or August. But Mike Moy, a managing director with PCA, says “it certainly won’t be [presented] in August,” adding that early fall is a more likely time frame. Moy is in charge of conducting interviews for the review.

The delay is unlikely to alter PCA’s findings, but could cause some timing problems for some of CalPERS’ discretionary advisors. Grove Street Advisors, for example, is soon expected to run out of dry powder for its California Emerging Ventures program, which serves as the primary vehicle for committing to venture capital funds (once anticipated follow-on commitments are taken into account). The program could be renewed by the CalPERS Investment Committee, but the system does not plan to take any such action until the strategic review is completed.

– Dan Primack

Garden State Plants Seeds of PE

The New Jersey State Investment Council (SIC) has made its first commitment to private equity with $325 million spread among three funds:

  • Awarded $200 million to Warburg Pincus, which has a goal of raising $7.5 billion for buyout, venture and other structured investments. The fund has a 1.5% management fee and a 12-year term with a two-year extension, according to the SIC.
  • Committed $75 million to Oak Hill Capital Partners, which is raising a middle-market buyout fund with a goal of $1.75 billion. The management fee of the fund begins at 1.75% but drops to 1.25% after its commitment period. The fund has a hurdle rate of 8%, according to the SIC.
  • Committed $50 million to Quadrangle Capital Partners. The firm’s second fund is a middle-market buyout vehicle with a $1.25 billion goal. The fund has a 1.75% management fee with an 8% hurdle rate, according to the SIC.

The state pension fund manages nearly $70 billion in assets. The SIC earlier approved a 13% allocation to alternative investments to be achieved in the next five to seven years. Of the total allocation, 5% is earmarked for private equity investments, 4% is allocated for real estate and the remaining 4% is reserved for hedge funds.

The SIC will commit between $1.5 billion and $2 billion in the first fiscal year of the private equity program, about $1.5 billion in the second year and $1 billion in the third and fourth years.

Strategic Investment Solutions is so far the sole private equity advisor to the SIC.

Previously, New Jersey pensions had invested in stocks and bonds. But the pension system took heavy losses with the bursting of the tech bubble four years ago and the value of its holdings dropped from $82.6 billion in June 2000 to $60.2 billion by August 2002.

Large losses from public equities underscored the state’s need to diversify, says New Jersey State Treasurer John McCormac. His office had commissioned a report by Independent Fiduciary Services that was published last year and called on New Jersey to “more broadly diversify its investment portfolio [by] adding further, nontraditional asset classes and strategies” through outside managers.

The Communications Workers of America and the New Jersey Teachers Association have filed lawsuits seeking to block the proposed changes. They claim that the SIC needs the approval of the state legislature to make the proposed changes.

Union activists concede that the plan will not cost any state workers their jobs. But they maintain that it is too risky to put money into alternative assets and to pay millions of dollars in fees to outside investors. The lawsuit is pending in the Superior Court of New Jersey in Trenton.

Meanwhile, New Jersey State Sen. Peter Inverso and his assembly colleague Rep. Bill Baroni, both Republicans, have begun efforts to have the legislature assert its authority and block any changes to the state’s pension investments without the legislature’s approval. Their district is home to a large number of state workers.

– Matthew Sheahan

More LPs Jump into Fray

The market couldn’t get more crowded with limited partners if PPMs came with free beer. A new survey confirms that more LPs want to invest in private equity and others want to increase their allocations. The survey by JPMorgan Asset Management New Sources of Return Survey shows that large institutional investors are looking to private equity to bring in better returns.

The survey was conducted this year and examined the investment practices of 120 large, public and private pension plans. Both public and private pensions have portfolio allocations in alternative investments that average 10 percent, according to the survey.

The survey says that 81 out of 120 plan sponsors, or 68% of those surveyed, plan to make changes to their allocations to enhance returns. Of those, 75% said they would turn to private equity.

Lots of LPs have made moves recently to increase their PE exposure:

  • * New York City’s Comptroller William Thompson has been pursuing a strategy of increasing New York City’s exposure to private equity through its various public pensions. A spokesperson for his office told VCJ that the Big Apple’s pension systems are “exactly on target” to meet their goal of having $1.2 billion in private equity by the end of the year. New York City’s pensions have so far invested approximately $600 million in the asset class. The city most recently invested in funds managed by Aurora Capital and Prism.
  • New York State Common Retirement Fund (CRF) is mulling a liberalization of its investment rules to allow more PE investments. New York State Comptroller Alan Hevesi is leading an effort to increase the private equity portfolio of the CRF through legislation that would liberalize investment rules. For the CRF, the driving motivation is the generation of healthier returns. In the five years between 1999 and 2003, the CRF would have generated between $4 billion and $5 billion more in returns had it been able to allocate more to alternative investments, according to Hevesi’s office.
  • The staff of the California State Teachers’ Retirement System (CalSTRS) recommended a series of policy changes to help the pension system reach its target alternative asset allocation of 8 percent. Achieving the 8% allocation would increase its alternative investment holdings to $10 billion and put almost $4 billion more into circulation.
  • Mississippi’s governor in March signed into law a bill that allows the $16 billion Public Employees Retirement System of Mississippi to invest in alternative assets.
  • New Mexico’s governor signed a law in April that allows the $6.7 billion New Mexico Educational Retirement Board (ERB), the $10 billion Public Employees Retirement Association (PERA) and $12 billion State Investment Council (SIC), to invest in areas of alternative assets previously prohibited them, including private equity.
  • The New Jersey State Investment Council approved a plan to invest 13% of its $66 billion in assets into alternative investments. The plan would allocate 5%, or about $3.3 billion, of its assets to private equity.

– Matthew Sheahan

Pensions Have Taste For More

A new survey says that pension funds worldwide invested more than $62 billion in alternative assets last year. The survey, which was conducted by Watson Wyatt Investment Consulting and released in June, found that pensions invested $17 billion in private equity in 2004.

Private equity, real estate and hedge funds together grew by $161 billion last year, bringing the total capital managed in alternative assets to about $1 trillion.

The survey found that real estate is the most popular alternative asset class for pension funds in Europe and North America, with private equity and hedge funds coming in No. 2 and No. 3, respectively. Asian pensions reported the opposite, with hedge funds being the most popular alternative asset class.

Private equity pros increased their assets by 14% last year and now manage about $193 billion. Private equity accounted for 17% of new alternative investment capital from North America, according to the survey. The survey also found that private equity makes up 38% of all alternative assets managed.

Roger Urwin, Watson Wyatt’s global head of investment consulting, said in a statement that pension funds around the globe have heard the message of diversification, and private equity has benefited from that.

“Private equity is slowly gaining acceptance among pension funds globally as a logical addition to their portfolios,” he says.

Hamilton Lane Advisors manages the largest amount of advisory assets in private equity with about $39 billion, according to the survey, whereas Pacific Corporate Group manages the most in private equity fund-of-funds assets, with $22 billion.

The survey gathered data from 125 fund managers.

– Matthew Sheahan

CalPERS Sets New Rules

Earlier this summer the nation’s largest public pension adopted more stringent regulations regarding conflicts of interest among pension investment consultants. CalPERS announced that its board of administration adopted new policies regarding disclosure of potential conflicts of interest among its investment advisors

The new policy requires investment consultants to “identify any future circumstances that may create actual, potential or perceived conflict of interests prior to providing advice in a specific subject or investment.” Any potential future investment consultants would be required to disclose such conflicts as part of the bidding process for contracts. The new policies go above and beyond CalPERS’ current practices, which rely on disclosures and SEC documents.

CalPERS’ policy says a conflict exists when an advisor knows or has reason to know that any friend, relative or associate has an interest that is likely to bias the advice he or she gives to the pension system.

The pension system’s announcement cited a recent report by the SEC that found more than 50% of pension consultants and their associates served both pension funds and money managers.

But in its efforts to insure uncorrupted investment decisions, the pension system may be putting too heavy a burden on its advisors, some legal observers note. “It’s safe to say that the conflict of interest policy adopted by CalPERS does go beyond what they’re required to do under law and it’s questionable whether there’s any really corresponding benefit to what investment consultants are being asked to provide,” says attorney Michael Littenberg, a partner with Schulte Rogh & Zabel. He warns that CalPERS’ definition of what constitutes a conflict may be too broad and cause advisors to take a more narrow view of what constitutes a conflict. “Notwithstanding the staff inspection that was referred to, existing policies and procedures that they have in place are probably effective with a little bit of ad hoc supplementing on a case-by case basis.”

CalPERS uses approximately 28 pension consultants for its investment portfolio. In April, the pension system again picked Santa Monica, Calif.-based Wilshire Associates as its primary pension consultant. Wilshire has served CalPERS in that capacity for the past 22 years and is credited with overseeing CalPERS Permissible Market Equity Policy and authoring a study of the effects of the pension fund’s policies. The firm’s contract will be effective July 1 and last three years with the option of two one-year extensions. Grove Street Advisors, Pacific Corporate Group, the PrivateEdge Group and Hamilton Lane Advisors have also served the pension giant.

– Matthew Sheahan