- 2017 among CalSTRS’s most active years for new PE commitments
- CalSTRS cracked $7 bln of commitments in 2006 and 2007
- PE’s average fund size more than double what it was in 2011, reports Meketa
California State Teachers’ Retirement System committed almost $7 billion to private equity funds marked as 2017 vintages, doubling the annual amounts it allocated to funds raised between 2014 and 2016.
CalSTRS, whose $17.9 billion PE program is among the largest in the country, ratcheted up its exposure even as private equity firms pay increasingly high prices for new portfolio companies, according to a presentation CalSTRS PE consultant Meketa Investment Group prepared for its May 9 investment committee meeting.
Purchase prices on new U.S. M&A deals approached 10.5x Ebitda last year, the presentation says. The average amount of debt used to finance new deals in the U.S. climbed close to 6x Ebitda, a level that hasn’t been seen since prior to the recession.
Rising valuations corresponded with a similar hike in fund sizes. The Meketa presentation, which cites data from Pitchbook and Preqin, reports the average fund raised in 2017 topped $1.1 billion — more than double the $543 million PE firms averaged in 2011. The median fund size increased from $200 million to $302 million over the same period.
Some LPs have started to sound the alarm on the fundraising boom, particularly in conjunction with rising prices and the duration of the economy’s growth cycle. Some market dynamics mirror those present in the years leading up to the previous economic downturn.
As recently as 2015, CalSTRS was signaling it was prepared to make “hard choices” in approaching the glut of new funds on the market.
“With much of the industry in high-harvest mode, managers are fundraising on a more frequent basis,” staff wrote in a 2015 investment plan. “To ‘invest through the cycles’ staff must remain disciplined and make hard choices to avoid being swept along by the increasing momentum of the fundraising cycle.”
It’s familiar territory for CalSTRS, which committed heavily to private equity in the years leading up to the global financial crisis, according to the Meketa presentation. The retirement system allocated more than $14.5 billion to new funds raised in 2006 and 2007, more than any other two-year period since the program’s inception in 1988.
Those pre-crisis funds ultimately underperformed. CalSTRS’s allocations to funds raised in 2006 and 2007 were netting 6.9 percent and 7.5 percent respectively as of Sept. 30, 2017, falling short of the 8 percent threshold many funds must clear before the general partners can collect their share of the return (see chart).
CalSTRS Commitment Pacing and Performance by Vintage Year
|Year||CalSTRS Commitments||CalSTRS Net IRR|
Source: CalSTRS and Meketa
“Those vintages are not going to end up terrible,” CalSTRS Director of Private Equity Margot Wirth told Buyouts in 2014. “We just had a very high exposure to those types of funds.”
The performance of its pre-crisis holdings likely had some bearing on CalSTRS long-term returns. The PE program failed to meet its benchmark on a 10-year and 5-year basis, net of fees, according to a staff report included in its May meeting materials.
The portfolio outperformed benchmarks in the short-term, and distributed some $11 billion to CalSTRS since 2015, according to the Meketa presentation. Strong distributions contributed to CalSTRS’s need to commit additional capital to new funds to maintain its 8 percent short-term target allocation to the asset class.
In recent years, CalSTRS sought to move away from funds at the larger end of the market, opting instead to back funds raised by smaller firms targeting mid-market or growth equity deals.
Its activity in the second half of 2017 included commitments to growth equity and mid-market funds raised by firms like Francisco Partners, Summit Partners and Valor Equity Partners, in addition to megafunds raised by Carlyle Group, GSO Capital Partners and Onex.
The largest single commitment during H2 was a $350 million allocation to Olympus Partners’s new $3 billion growth equity fund.
CalSTRS also boosted its allocation to co-investments. The investment team is reviewing strategies to bolster its ability to make direct investments in private companies as well, according to retirement system documents.
CalSTRS declined comment.