The private equity secondary market is readying itself for what could be a defining moment. One of the private equity world’s most active limited partners, the California Public Employees’ Retirement System (CalPERS), is considering a sell-off of private equity partnerships to the tune of about $3 billion. Such a large amount of assets going on sale would get secondary buyers vying for pieces of the portfolio and would encourage other large LPs to follow suit.
At the end of March, CalPERS issued two requests for information (RFI) as part of its strategic review that will see the $200 billion pension system reduce its directly held private equity fund investments significantly. One RFI asks interested groups to submit plans for managing partnerships in its portfolio. The other RFI asks for respondents to submit plans to help create new investment vehicles (NIVs). Both plans would serve CalPERS’ $28 billion Alternative Investment Management (AIM) program.
The CalPERS Investment Committee approved a proposed action plan at its Dec. 12 meeting to overhaul the structure and management of the AIM program. The plan calls for the $200 billion pension system to reduce the number of private equity relationships it manages and realign its management structure.
It is the pension system’s request to transfer management of partnerships that has secondary firms most interested. CalPERS plans to sell off about $3 billion in assets: $2 billion in invested partnerships and $1 billion in unfunded commitments. As of the end of last September, the pension system had 412 active funds being managed by more than 100 general partnerships.
CalPERS will essentially divide its alternative assets portfolio into five parts. Its core portfolio will consist of approximately 20 to 30 already existing private equity firm relationships. It will also have a prospective core portfolio of between 30 and 40 existing and new relationships, a more developed co-investment portfolio, and a portfolio of “discretionary vehicles” comprised of third party managers making smaller investments.
The fifth part of the revamped CalPERS AIM structure would be a legacy portfolio that would consist of “non-core relationships, underperforming management teams, and retiring relationships.” It is this legacy portfolio that presents the greatest opportunity to secondary buyers, and CalPERS intends for it to be managed by a third party. It has set out to “retire” funds not performing up to par and “explore opportunities to sell investments in the secondary market” over the next three years.
While the RFIs released by the pension system do not explicitly state that it will sell private equity assets on the secondary market, many agree that secondary sales will most likely be a significant part of its restructuring. CalPERS is already a limited partner to the large secondary firms likely to be in the best competitive position in the sale. Firms such as Coller Capital, Lexington Partners and Landmark Partners all count the pension system as an LP. CalPERS will likely hand over much of its private equity management to established advisors and other third party investors.
“They’re doing exactly the right thing and they’re doing it in a big way,” says Stephen Can, managing director at Credit Suisse Strategic Partners, one of the secondary market’s large buyers.
Such a sale would not be anything new for public pensions, which routinely sell private equity assets on the secondary markets. They did so more frequently several years ago when a steep drop in stock prices left their private equity asset allocations above their legal mandates. The difference here is the size and the scope of the sale as well as the high profile of the seller.
“CalPERS is sort of a bellwether,” says a partner with one of the secondary market’s large established firms. “More people look to CalPERS than look to other public pension funds as a barometer. This could be a catalyst for massive transaction opportunities.”
Can agrees that the sale could be paradigm shifting. Whereas LPs are now viewed as forward-thinking for selling on the secondary market, after a CalPERS secondary sale of this magnitude, LPs not managing their portfolio with secondary sales will appear to be behind the curve. “There has to be some type of portfolio management periodically,” he says. “People should be looking at what they have and seeing if what they have still makes sense. A lot of groups have never done that and they should.”
While secondary firms are largely keeping quiet, it’s no secret that many if not most of the big players are looking to buy what CalPERS puts on the market. Can says that there is a big potential for secondary firms to form consortiums for bids on these assets.
A CalPERS spokesman says that while there’s no timeline for signing contracts since negotiations can take weeks or months, the target will have the third party manager(s) in place by the fall.
Secondary buyers are enthusiastic about not only the chance to buy portions of CalPERS’ well-regarded portfolio, but also about the message it will send to other LPs: that selling assets on the secondary market is a vital part of portfolio management. “You invest long term,” says Can, “but long term isn’t forever.”