Three months after its investment committee suggested an opportunistic move that would allow the pension fund to commit up to $300 million to distressed debt funds, the California State Teachers’ Retirement System (CalSTRS) made its first move into the sector with a $25 million investment in Angelo, Gordon Capital Recovery Partners III LP.
This investment marks the first time Sacramento-based CalSTRS has invested with Angelo, Gordon & Co. LP. The deal will close pending the completion of legal review and successful negotiation of investment terms.
New York-based Angelo, Gordon is in the market with a $1 billion offering that will tackle the secured and senior debt of troubled companies. The firm raised its most recent fund in 1999, a $600 million turnaround fund.
At its February meeting, CalSTRS’ investment committee voted to allow its investment staff to make full use of its distressed allocation in order to hedge against losses in its private equity and venture capital portfolio. Currently the plan’s alternative investment portfolio is worth $4.4 billion, or 4.4% of the system’s $101 billion total value. Distressed debt is considered part of CalSTRS’ alternative investment portfolio, which also includes venture capital and buyout funds. CalSTRS’ asset allocation mandates that up to 5% of its alternative investment portfolio, or approximately $300 million, can be held in distressed debt securities.
The investment team’s focus on distressed debt began in late August, just as state controller and CalSTRS investment committee member Kathleen Connell warned that a California state budget shortfall would not allow the state’s general fund to cover CalSTRS’ unfunded liabilities. Although CalSTRS is currently fully funded, falling returns in its public and private equity portfolio make distressed debt an attractive option. Elite distressed debt managers, says Connell, have achieved consistent returns of 25%.
“We’re not going to be in a position to write those checks from the general fund in the future,” Connell said at the investment committee meeting. “It’s counter-cyclical to go into distressed debt. I would not have recommended it two years ago, but it is a great asset class to be in now. Given the state of the public equity markets, it is an asset class we need to consider.”
Connell drafted an open letter on Feb. 1 to the fund’s investment team recommending the move into distressed debt. CalSTRS’ cross-town rival, CalPERS, the nation’s largest public pension fund, with $144 billion under management, also has made moves into distressed debt in recent months.
Still, Connell’s proposal raised questions as to whether the increased allocation to distressed debt would violate the system’s asset allocation targets. In March, the committee decided it would be appropriate to invest opportunistically in the asset class since it fell within the plan’s current asset allocations.
According to CalSTRS, its investment in AG Capital Recovery Partners III is not just opportunistic but also a chance to invest with one of the “oldest, largest and well-respected distressed businesses in the country.” Angelo, Gordon was founded in 1998 and manages approximately $9 billion.