NEWPORT BEACH, Calif. -Ronn Cornelius wants to see some real commitment from general partners before investing in a new fund. “I like to see that the GP’s have a lot of skin in the game, because that tells me they are committed and it will drive them to get every last ounce of value out of a deal,” said Cornelius, a director of private equity at Pacific Life Insurance Co.
Over the next two years Cornelius and his co-director Sam Tang will look for that kind of commitment in a unique place. The duo plan to invest as much as $240 million in secondary private equity funds. This figure represents about 80% of the $300 million Pacific Life plans on committing to private equity in that time span. The large percentage demonstrates both the company’s commitment to the secondary side of the market, as well as its willingness to take advantage of what it sees as an attractive market opportunity.
Pacific Life, which has been investing in private equity for 20 years, has an overall target allocation of 50% of its capital to secondary funds. The company made its first investment in a secondary fund in 1990 when it was the lead investor in secondary player Landmark Partners Inc.’s first institutional fund. Pacific Life’s secondary allocation currently stands at 45%, which is one reason it will over-allocate to this category over the next two years. The company has invested in 20 secondary funds with seven fund managers worldwide over the last 10 years, including Lexington Partners and Credit Suisse First Boston.
“The returns of our secondary funds have all been top quartile plus,” Cornelius said. “With a secondary, you aren’t investing in a blind pool, you know what you are getting and you are closer to the cash flow streams, so there is less volatility…to us the risk adjusted return is far superior.”
Moreover, now is a particularly attractive time to invest significantly in secondary funds given the tremendous amount of fund raising that has taken place over the last few years, Cornelius said. “We think the amount of selling pressure on some LPs should be up, maybe because of M&A activity, or because some groups that just came into venture capital because of the hype surrounding the market, but who are not really long-term players, which means they should be sellers,” he explained. “With less capital out there to buy secondaries than there are sellers looking for buyers, that is an inefficiency, which should drive strong returns in the next 10 years.”
Pacific Life, with a private equity portfolio of roughly $1 billion, began investing in private equity because it sees greater opportunity to generate strong returns than the public equity markets, Cornelius said. The company’s public equity holdings are quite small by comparison, he noted. Pacific Life’s targeted return for its private equity program is above 20% IRR and two times multiple return on capital, he added. Over the last 11 years Pacific Life has outperformed both the public markets and the top fund managers in their vintage years, Cornelius said.
Picking Your Partners
Pacific Life’s private equity portfolio is comprised of 32% buyout/growth capital funds, 30% venture vehicles, 20% international funds, 12% specialty sector funds vehicles and 6% mezzanine funds. “We have built a lot of models and based on the primary market, secondary market and co-investment opportunities we think this approach gives us the best diversification and return profile over the next 10 or 12 years,” Cornelius said.
Pacific Life typically receives 200 to 300 investment opportunities in a given year, while the company usually only makes between eight and 10 investments per year. “We look for groups that fall into different segments and mixes we have targeted, like we may know we want to back one or two firms that invest in Asia, so we will keep that in the back of our mind as we sort through opportunities,” Cornelius said. “But in the end you are really backing an investment manager, not a firm’, so we want to see some differentiation, like sustained success and performance history that make us comfortable enough to invest.” This means Pacific Life was not very excited by the 150% IRRs posted by some firms during the heady days of the Internet bubble because it did not demonstrate long-term success.
The firm’s average investment in a typical private equity fund ranges from $10 million to $20 million, while investments in secondary funds can range from $10 million to $75 million. Firms receiving investments from Pacific Life for the first time generally receive $5 million to $10 million.
Given its investment criteria, Pacific Life generally does not invest in first-time funds or even established funds it is seeing for the first time, Cornelius said. The best way for a new firm to approach Pacific Life is through a recommendation from an industry insider whom Cornelius or Tang knows well. “This is like a first due diligence screening – we can ask someone we trust about the potential opportunity,” Cornelius said.
For future investment opportunities, Pacific Life will keep tabs on promising firms that did not quite clear the final hurdle, he added. “We call it holding hands’ that means we keep in touch with them and they let us know how they are doing and that enables us to get a better sense of their process, how they make their decisions, so we can have a better sense of who they are the next time.”