Connecticut’s in-state program: Co-investments close to home

“This is a very simplified method by which we can make direct co-investments that come to us through our private equity portfolio,” Terrence Purcell, the state’s principal investment officer for alternative investments and private equity, said in a recent interview. “We haven’t had a formal co-investment platform before. All of our private equity investments have been in commingled funds.”

A proposed $150 million separate account with J.P. Morgan Private Equity Group includes $50 million for opportunistic investments in Connecticut-based companies. The pension also proposed carving out $20 million from a $180 million a separate account with Fairview Capital Partners for direct co-investments in local early stage companies, according to retirement system documents. Along with the in-state co-investment portions of their mandates, the separate accounts will invest in private equity and venture funds.

Beyond co-investments, the pension plans to support local businesses through a lending program. It has proposed committing $75 million to a fund to be managed by Balance Point Capital Partners, which would provide loans to middle-market companies in Connecticut.

“It opens the door to all shapes and sizes of companies in Connecticut,” Purcell said. “All of a sudden, a very, very full range of companies in Connecticut know that this program exists.”

The hope is that co-investments targeted by the accounts, particularly those in companies operating in underserved communities, will spur local investment while generating market level returns, achieving a “double-bottom line,” Connecticut Treasurer Denise Nappier told Buyouts in an interview.

“What better way to target some of our investment dollars to Connecticut businesses that pay taxes in our state and hire people in our state?” Nappier said. “It’s a win-win proposition.”

Connecticut has formed accounts with J.P. Morgan and Fairview in the past. The state committed $110 million to a J.P. Morgan fund of funds separate account for Connecticut in 2010 that produced an 11.7 percent internal rate of return as of Dec. 31, according to state documents. Fairview has delivered a cumulative 12.7 IRR across three funds of funds since taking over the state’s venture funds of funds program in 2004.

Better terms

While the accounts were still subject to negotiation as of press time, the terms offered by Fairview and J.P. Morgan offer better alignment of interests and significant discounts on management fees compared to what Connecticut paid for its previous funds, according to state documents and interviews with state officials.

Both J.P. Morgan and Fairview are existing managers in Connecticut’s $29.4 billion investment portfolio, and staff benefitted from its longstanding relationships with both managers.

“These managers understand the importance of having a long-term relationship with Connecticut, and they’re fair,” Nappier said.

Even though the carve-outs for in-state co-investments represent an expansion on the strategic scope of both firms’ existing mandates, Connecticut is poised to secure significant fee discounts on its new accounts. J.P. Morgan changed its management fee to a 0.6 percent charge on the capital it invests, rather than 0.6 percent of Connecticut’s committed capital, according to state documents.

J.P. Morgan also added an 8 percent preferred return on the fund-of-funds component of its new mandate, called Nutmeg Opportunities Fund II, according to retirement system documents.

Fairview offered similar discounts. The firm reduced its management fee from 0.8 percent during the investment period to 0.65 percent, which was offered for Connecticut’s previous account, according to an outline of proposed terms.

“I think we’re taking advantage of Connecticut’s size and leverage to establish these separate accounts,” Purcell said. “It can move the needle from a fee basis and a cost basis.”

Despite being a new relationship, Balance Point’s management fee on the account also is a discount from what it offers investors in its commingled fund, Purcell said. The firm is charging Connecticut 1.5 percent of committed capital during the five-year investment period and 1.5 percent on invested capital thereafter.