PA Schools CIO: Pension will remain a sought-after LP despite team turmoil

Pennsylvania Public School Employees’ Retirement System will continue to slow the pacing of its private equity program as it works to shrink its allocation to the asset class as it works to rebuild after the departure of most of its PE team, the system’s chief investment officer told Buyouts.

The $69.8 billion system’s recent upheaval reflects the strains that overallocations and reduced cashflow can play in managing a large private equity portfolio. Since October, four of the five members of the system’s private equity team have retired or taken roles elsewhere.

This all unfolds as PA Schools moves on from a drama caused after former consultant AON miscalculated the system’s investment returns. Last week, AON agreed to pay $1.5 million in fees and penalties as part of a settlement with the SEC.

The AON incident resulted in many changes at the top of the system, including the hiring of CIO Benjamin Cotton, which was announced last January.

Changing allocations

The system first lowered its target allocation to private equity in 2020, reducing it from 17 percent to its current 12 percent target. Last year, the board approved a reduction of its total basket of alternative investments from 36 percent to 30 percent. The system currently allocates more than 17 percent of its total fund to private equity, according to board documents.

The reduced allocation led to the system committing $300 million to private equity last year, from the $1.5 billion in 2020. Cotton said he expected to use reduced pacing going forward to move the private equity portfolio closer to its target.

The steep reduction in annual commitments runs contrary to the advice of many consultants, which is that investors should have a steady pace across vintage years.

Cotton said he looked at pacing models more as a “planning tool” than as policy, citing the challenges using backwards-looking assumptions – especially when interest rates are quickly changing, leading to a difficult exit environment.

“What I suspect will happen is that eventually buyers and sellers will come to terms and we will find the distributions working similar to how they did in the past. But, until then, we have to manage accordingly and I think it’s appropriate to moderate our pacing as a result,” Cotton said.

Cotton did not rule out the possibility of a secondaries sale to reduce the target.

“No options are off the table. Primarily, it’s through pacing. We’re not in the market right now to do a secondary sale. But I’ve certainly asked the team to think about what our options are and to make sure that if the opportunity provides itself for us to efficiently act in the market to manage our portfolio that we’ll take that opportunity,” Cotton said.

Cotton does not expect that managers would ignore PA Schools when raising new funds despite the reduced pacing and upheaval within its private equity team.

“We have a long history of underwriting managers that we have a high conviction in. We have a great team here, many who have been here for a long time, and we’ve got a really talented group of individuals. We expect that general partners will still want to work with us, and we haven’t seen any indication that’s going to change,” Cotton said.

Not a one-man team

PA Schools’ $12.2 billion private equity portfolio holds more than 300 funds across 70 managers, according to board documents.

This means there is currently only one private equity team member to handle all of the work that goes into maintaining a portfolio of that size – let alone any of the tasks needed when considering future commitments.

Cotton said he was not worried about the departures’ impact on managing the portfolio.

“I’ve got a 60-person team, and a big portion of that team is focused on private markets. And, outside of that, there’s also a big portion of my team that’s in a support role for private markets, and then we get a tremendous amount of support from our consultants,” Cotton said.

In addition, Cotton said he has prioritized shifting PA Schools away from a “siloed” approach and more collaborative across asset classes – including an in-house “asset implementation” committee used when vetting potential underwriting decisions.

This type of approach would lead to staff making more decisions that are “additive” to the total portfolio as opposed to specific to one asset class, Cotton said.

“When we go to the job market, we’ll hire new analysts and we’ll tell them, ‘Look, your focus is 50 percent on a specific asset class, and then the rest of your time is learning how to support the rest of the team. And as they develop, we find other opportunities to get them experience across all the different flavors of asset allocation,” Cotton said.

Exit strategy

Four of the team’s five members announced their departures since October. Longtime director of private equity Darren Foreman will retire in January after working at the system for 21 years.

According to their LinkedIn profiles, former senior portfolio manager Patrick Knapp was named director of investments for William & Mary University’s foundation. Philip VanGraafeiland is now the director of private equity at Police and Fireman’s Retirement System of New Jersey. Tony Meadows works for women’s-focused VC platform Sinefine.

None of the departing team members commented for this story.

According to sources, investment staff grew frustrated with the reduced commitment pacing.

“It’s disheartening. They all started and saw their work as purpose driven for the beneficiaries. It’s been taken away from them,” said one source, who regularly worked with the private equity team.

Cotton said that, even with the reduced targets and pacing, the system’s 30 percent allocation to alternatives was still significant.

“I can certainly empathize with the frustration associated with a higher target going to a lower target and the aspects of managing that. But I would say that we still have a very significant allocation to private markets, and private equity makes up the lion’s share of that. We’re not changing that anytime soon,” Cotton said.

Based on net IRR, PA Schools’ private equity portfolio was the system’s best performing asset class over the past three-year, five-year and 10-year time periods.

According to board documents, the PE portfolio generated $1.9 billion in distributions against $1.5 million in contributions in 2022. Since inception, the portfolio generated $43.7 billion in distributions against $34.9 billion in contributions.

“I think it’s delivered on the expectations that we’ve set for it, and the team that has been working on it before and now have done a great job of moving that along,” Cotton said about the PE team’s performance.