Pension System: California State Teachers’ Retirement System
Assets Managed: $145 Billion (Dec. 31, 2011)
Invested Private Equity Capital: $21.3 Billion (Dec. 31, 2011)
Current PE Allocation/Target: 14.7 Percent/12 percent
Chief Investment Officer: Christopher Ailman
The $145 billion California State Teachers’ Retirement System, the nation’s second largest pension fund, is actively considering making large separate account commitments for its private equity program, a senior investment official at the fund told Buyouts. The development that comes on the heels of mega-separate account commitments from the Texas Teachers’ Retirement System and the New Jersey Division of Investment.
“We’re definitely looking at separate managed accounts,” said Pascal Villiger, a private equity portfolio manager at CalSTRS. “It’s definitely something that I think all large institutions are seriously looking at.”
Late last year, two giant commitments shook the private equity world. The first, by Texas Teachers’, involved committing $3 billion each to separate accounts from Apollo Global Management and Kohlberg Kravis Roberts & Co. These investments would be highly specialized and spread over a variety of strategies that the two firms would manage in partnership with Texas Teachers’ own portfolio managers.
A few weeks later, New Jersey pledged $1.5 billion to The Blackstone Group for three separate accounts across different strategies. This was in addition to $1 billion that New Jersey had already pledged to Blackstone Group in 2011 for its regular slate of private equity and real estate funds.
Large separate account commitments represent a sea change in the way public pension funds, the largest sources of private equity money, are using their huge size to drive down fees and negotiate better terms. Such arrangements also highlight how the biggest private equity firms are seeking to meet their clients’ needs by expanding beyond their main buyout businesses into a variety of areas, even beyond private equity itself, such as real estate and commodities.
These separate accounts are fundamentally different from typical private equity funds in that the investments are not commingled with money from other investors, but rather focused on customized investments and strategies for just one investor.
Separate accounts are also likely to help accelerate the ongoing transformations of the largest private equity firms into generalist asset managers equipped to offer their clients a wider scope of investments beyond private equity. Blackstone, for instance, now manages $137 billion in fee-earning assets, yet only 27 percent of its assets ($37 billion) are invested in private equity, the rest being invested in real estate, hedge funds and credit offerings.
A major accelerator of this diversification of investment offerings is the fact that several of the largest private equity firms, including Apollo, Blackstone, KKR and TheCarlyle Group have gone public or plan to do so, and as such, desire a more diversified range of revenue sources that deliver more consistent returns.
Even though large separate accounts are relatively new in private equity, CalSTRS’s Villiger said there were already a variety of approaches. “There is a spectrum of flavors,” he said. “At one extreme, it’s just basically co-investments alongside a comingled fund with reduced economics. At the other extreme, in terms of Texas Teachers’, it’s a very highly customized solution.”
Kelly DePonte, a placement agent at Probitas Partners, said the recent moves by big pension funds to consider separate accounts represent much more than a desire to save on fees. “It’s also a wish for more control,” he said, “so that there is more of a conversation between the GP and LP about each individual investment.”
DePonte added that separate accounts were just one type of investment that helps pensions gain more control. “Separate accounts, co-investments and direct investments are all part of this dynamic,” he said.
CalSTRS’s move to consider large separate accounts was strongly hinted at in late January, when the pension publicly posted proposed changes to its private equity investment policy that would allow such investments. The pension’s board was scheduled to discuss the policy changes at its February board meeting.
In making its case, the proposal highlights the advantages of separate managed accounts, among them, “discounted fees and preferred terms,” adding that “almost always, management fees will be lower and sometimes carried interest will be lower too.”
The proposal strongly suggests what CalSTRS may be considering. Under the proposed policy, each separate account would be limited to 10 percent of CalSTRS’s private equity portfolio. But since CalSTRS has $21.3 billion in private equity holdings, it is feasible that separate account commitments could amount to as much as $2 billion each.
The proposals also disclosed that CalSTRS was “among the select group of limited partners which is now frequently offered separately managed accounts by private equity managers.”
To be sure, separate managed accounts would probably represent just a fraction of CalSTRS’s overall private equity strategy. Villiger said that at 14.7 percent of its overall portfolio in private equity, CalSTRS was already over its 12 percent policy target. That said, he predicted that CalSTRS would probably spend between $2.5 billion and $4 billion on private equity each year. “A sustainable pace is probably a number closer to $4 billion,” he said.
One baby step by the pension toward large separate accounts came on Feb. 7, when CalSTRS announced it would be making a $500 million commitment to a specialized infrastructure fund run by Industry Funds Management, an investment firm with $31 billion under management and which is owned by a consortium of 32 Australian pension plans.
The commitment to IFM’s Global Infrastructure Fund would be one of the largest ever by a U.S. pension fund to the infrastructure space. Christopher Ailman, CalSTRS’s chief investment officer, said in a statement, “CalSTRS is relatively new to the sector, and we wanted to get to know it before venturing beyond the fund structure.” IFM invests mainly in North American and European infrastructure projects such as utilities, ports and transportation projects.
Generally speaking, U.S. pension funds have lagged in making infrastructure investments compared to their Canadian counterparts. One of Canada’s largest pensions, the Ontario Municipal Employees Retirement System, has its own infrastructure investment arm called Borealis Infrastructure, which has made several infrastructure investments in North America and Europe, often in coordination with other Canadian pensions.
Despite a late start, however, some big U.S. pensions have already got their feet wet. The $234 billion California Public Employees’ Retirement System, the state’s other giant pension fund, recently started making one-off infrastructure investments, including an undersea electric cable that connects New Jersey with Long Island, New York, as well as a minority stake in London’s Gatwick Airport, which was in partnership with Global Infrastructure Partners, an infrastructure private equity fund.