Holdout States Succumb To Private Equity’s Charms

If Craig Slaughter had his way, the West Virginia Investment Management Board would have invested in private equity a long time ago. Joining as executive director of the pension fund in 1989, Slaughter knew the opportunity for high returns in the market in the 1990s. But explaining the asset class takes time.

“We couldn’t invest in stocks until 1997. You’ve got to walk before you can run,” Slaughter said. In 2000, Slaughter began working to expand the board’s investment horizons to alternatives. Earlier this month, the legislation was finally signed. “I’m excited but disappointed we weren’t able to do it six years ago,” said Slaughter, adding that the pension fund will have some appetite for buyout funds.

West Virginia, which has issued a request for information for third-party consultants to help build a program, is one of several small states that are on the cusp of moving into private equity or have just done so. Others include Arizona, Mississippi, South Carolina and Vermont. In the coming years, these states promise to funnel several billion dollars worth of new capital to the buyout industry, no doubt much of it through funds of funds.

Like West Virginia, South Carolina Retirement System took its time breaking into the asset class. Until 1999, its portfolio, now with $28 billion in assets, was entirely invested in fixed income instruments. Last November, a constitutional amendment passed allowing it to back private equity. It then carved out a 5 percent allocation to venture capital and LBO funds last fall, and last year it hired as chief investment officer Bob Borden, the former executive director of Louisiana State Employees’ Retirement System.

South Carolina made its first commitment this year, backing the $1.1 billion Aquiline Financial Services Fund, which is operated by former Marsh & McLennan Cos. head Jeffrey Greenberg. All told, the pension fund plans to commit $750 million to private equity funds this year, and $3 billion over the next few years. It was unclear how much would go to venture capital and how much to buyout funds.

The Public Employees’ Retirement System of Mississippi, with $21 billion in assets, is looking to ultimately allocate 5 percent to private equity. But it will be at least a year before one dollar from Mississippi is committed to a general partner. Following legislation which allowed the state to begin investing outside fixed income and equities, the pension is “really starting at square one” when it comes to private equity, said chief investment officer Lorrie Tingle. The pension is searching for a consultant now and wants to begin backing funds 12 to 18 months from now, she said.

Other pension funds appear poised to make similar moves into private equity investing.

Gary Dokes, chief investment officer of Arizona State Retirement System said the pension’s 5 percent allocation to private equity will include “all aspects” of the industry, from venture capital to buyouts. Right now, the $26 billion pension is looking for a consultant to help it develop a strategy. Dokes added that the pension’s level of activity in the industry will only be “what would make sense in a market where valuations are high.”

Trying to diversify, the $4 billion Missouri Local Government Employees Retirement System decided in January to put $200 million, or 5 percent, into small buyout and mezzanine funds over the next three to five years, said Chief Investment Officer Brian Collett. It has already backed one fund: the Bush O’Donnell Capital Partners Eagle Fund II, a mezzanine fund.

Meanwhile, Dave Minot, director of investments for the Vermont Pension Investment Committee, which oversees three pensions, said the process of breaking into private equity is “proceeding slowly.” Minot declined to comment on efforts to hire a discretionary advisor. The three systems will be looking to allocate 3 percent of its $2.9 billion in assets to private equity, said Minot.

In related news, other small states have been increasing their allocations to both LBO and venture capital funds.

Public Employee Retirement System of Idaho, which has $6.9 billion in assets, is reportedly trying to move to a 7 percent target allocation to private equity, up from 5 percent; the $14.6 billion Indiana Public Employees’ Retirement Fund recently moved from a 4 percent to an 8 percent target to private equity; and the $8 billion Louisiana Sate Employees’ Retirement System has jumped from 5 percent to 10 percent, according to a report. Exact allocations to buyout funds couldn’t be obtained for the pensions above.

“It’s not a question of whether” smaller, holdout states begin backing buyout funds, said Gary Appel, Vice Chairman of middle market buyout shop Castle Harlan, “but at what point in time do they cross the border.”—M.C.