Why TIAA-CREF Likes Buyouts Better than VC –

From her perch atop the alternative investments group at the Teachers Insurance and Annuity Association College Retirement Equities Fund (TIAA-CREF), Sheryl Schwartz believes the tide has started to turn and the industry should be on the upswing after a relatively prolonged slump the past couple years.

“We’re starting to see that things have begun to turn around,” Schwartz says. “Deal flow seems to be really picking up, access to leverage seems more available than it has in the past, and people seem to be sticking to their knitting.”

Anyone with a modicum of interest in what LPs think, ought to listen to what Schwartz has to say. TIAA-CREF, which manages over $280 billion in assets, is the world’s largest pension fund. The giant established its private equity investment program in 1997, growing its private equity allocation to $3 billion today. Schwartz manages a group of six professionals and oversees all private equity investment by TIAA-CREF. She has led the PE group since its inception.

“It was a lot like building a new business from scratch,” says Schwartz, who set up a team, researched the industry, made contacts and formed the group’s investment strategy.

Schwartz has been with TIAA-CREF for 15 years, traditionally the crystal anniversary year. She spent three years in corporate private placements, two years trading secondary private placements and four years in mortgage-backed and asset-backed securities prior to her current position. She consistently made money in her earlier positions, so when the organization wanted to go after private equity, Schwartz was the top candidate for the task.

“The best deals aren’t marketed,” says Michael O’Kane, a TIAA-CREF senior manager director and the person who picked Schwartz for her current position. “You have to find them, knock on doors, network.”

In choosing Schwartz to build the group he says he found someone who has persistence, the respect of the GP community, the deftness to handle big deals and the ability to ferret out the facts.

A Range of Investments

TIAA-CREF is an 80-year-old group founded to manage the retirement funds of the faculty and staff of the United States’ education and research communities. Over the decades membership has expanded from faculty and researchers to include the staff of libraries, teaching schools, hospitals, museums and, most recently, members of the public. Today, the group has more than 2.9 million participants from more than 15,000 institutions.

Internally TIAA-CREF is divided into two investing groups: TIAA, which invests in fixed income, real-estate and private equity opportunities, and CREF which only trades in SEC-controlled equities through its own mutual funds and annuities. TIAA is notably conservative: Less than 1% of the funds that it invests are allocated to private equity.

It invests in a range, from venture capital to buyout funds to distressed debt. While TIAA has used funds-of-funds to make investments, Schwartz and her group prefer to be more hands-on with their investment partners. About 55% of the group’s investments go to buyout funds, 25% to venture capital, between 8% and 12% to distressed debt and another 8%-12% to emerging markets.

Among the venture capital firms TIAA has invested in are Alta Communications, ComVentures, JPMorgan Partners and Walden International (see box on next page for a longer list).

In terms of investment sectors, Schwartz sticks with her diversification philosophy, investing across early and late stages in information technology and life sciences.

Since TIAA didn’t begin investing in private equity in earnest until 1998, Schwartz says it’s too early to assess how the group has done, at least in terms of generating any returns. TIAA isn’t public like the California Public Employees’ Retirement System, so its IRRs may never see the light of day.

While buyouts accounts for the largest portion of TIAA’s private equity portfolio, the firm doesn’t invest with some of the largest firms, such as Blackstone, The Carlyle Group, KKR and others. Schwartz says this reflects TIAA’s comfort level with and affinity for funds smaller than $1 billion. However, outside of the United States, the group works with larger funds.

Schwartz says that distressed debt, secondaries and buyouts remain the hot areas of private equity investing. Already this year, she has led TIAA-CREF in making roughly $500 million of new commitments to alternative investments, including funds focused on buyouts, venture, distressed debt, emerging markets, project finance and energy. That number comes on top of $100 million of co-investments. Going forward, Schwartz anticipates leaning a little bit more into the buyout space at the expense of venture capital, although she does not know where the exact allocation to buyouts will be.

“In the next few years we’ll probably have about the same [allocation], but we may move a little more into buyouts than venture,” Schwartz says, “It’s not so much because the opportunity of venture is not as good, but because venture capital is more volatile and TIAA is seeking to reduce the volatility in its private equity portfolio.”

And buyouts are appealing, Schwartz says, because there is plenty of corporate restructuring taking place among companies that made acquisitions during the go-go years and are now selling those acquisitions at attractive prices. Schwartz also attributes the emphasis on buyouts to her experience. She was previously at Irving Trust Co., where she was involved in fixed income, handling senior debt and mezzanine of buyouts.

The bad news for buyout shops is that Schwartz does not see TIAA-CREF expanding its inner circle of LBO general partners anytime soon. “We have a diversified portfolio by industry, stage and geography, and we’re trying to re-up with our existing relationships,” she says. “We’re happy with the ones we already have.”

Schwartz’s general investment philosophy for private equity is for broad diversification. In other words, she wants to spread her bets for the best possible returns by stage geography and fund. She concedes that she has been under-weighted in large U.S. buyout funds, reflecting her suspicion in 1997 when she started the group’s work, that the large buyout concerns were raising too much money, so she went for the mid-range partners up to $1 billion in size. Similarly in venture capital, Schwartz eschewed those VC firms asking for huge fees or 30% carries, and she has steered clear of the VC firms raising the biggest funds. If she had a chance to do some investments over, she says she wouldn’t invest in any first-time funds. “We did that when we started and they were not good performers.”

The most frustrating aspect of her job is spending time on issues that aren’t central to her mision of building wealth for her clients, like restructuring agreements with general partners. “Instead of working on the new investments and commitments, I have to spend my time on negotiating the reduction of a fund size and how to cover the clawback [issue properly],” she says.

Another frustrating part of her job that she’s learning to cope with is the 10-year cycle of private equity investments. “It’s difficult to tell how you’re doing because it constantly changes,” she says. “For an investor, that can be a bit frustrating because we want immediate gratification. But for this job you have to be calm and think for the long-term.”