Kentucky Pledges $300M to PE Amid Performance Criticism

Under a cloud of reproach for sub-par returns and for not having a high enough allocation to alternative assets, the Kentucky Retirement Systems is stepping up its private equity commitment pace, with at least $300 million having been pledged so far this year to buyout and venture capital funds.

The Kentucky Retirement Systems, which manages $15.5 billion of assets, recently committed $75 million to Crestview Partners Fund II, a mid-market buyout fund; $100 million to Duff, Ackerman, & Goodrich (DAG) Venture Fund IV (up from a previous commitment of $30 million); and it plans to commit up to $25 million to the KRS Opportunistic Venture Capital Fund, an in-house program run by staff. Earlier this year, the limited partner pledged $50 million to Essex Woodlands Health Ventures Fund III, a health venture fund, managed by Essex Woodlands Ventures, and $50 million to Vista Equity Partners Fund III, a technology buyout fund, managed by Vista Equity Partners.

The pension fund recently came in for criticism in a report published last month by the Kentucky Public Pension Working Group, which Governor Steve Beshear established in May “to review the investments of the state-administered retirement systems and to recommend policies and portfolio strategies based on investment returns and asset allocations of comparable public plan sponsors,” according to the Kentucky Finance Cabinet’s Web site.

In that report, consulting firm Hammond Associates Institutional Fund Consultants found that the pension fund’s one, three, five and 10-year period returns ending June 30, 2008, of –4.2 percent, 6.6 percent, 8.5 percent and 5.6 percent, respectively. The report compared those figures to an actuarial assumed rate of 7.5 percent. The other major concern was insufficient diversification, stemming from an “outsized exposure of more than one half of the portfolio invested in the U.S. equity market,” and from having had a lower allocation to alternative assets than the median pension fund, the report determined.

As of June 30, 2008, Kentucky Retirement Systems had a lower target allocation to alternative assets (10 percent) than its peers (14 percent), the report found. Hammond Associates is recommending that in the alternative portfolio, the pension fund focus on small and mid-market buyout funds that bring operating expertise to bear on their investments, while avoiding larger funds that depend more on leverage for returns. The LP defines alternatives as venture capital, private equity, leveraged buyouts, private debt, timberland, oil and gas partnerships, commodities, real estate and private placements.

Other problems at the pension fund unearthed by the report include inadequate investment oversight and an investment manager structure with concentrated positions that increase risk. The report suggested an overhaul of the investment committee; broader diversification among traditional and alternative asset classes; a review of poorly performing managers; and less concentration of managers.

In 2007, Kentucky Retirement Systems made pledges that included $75 million to Avenue Capital Groups Avenue Special Situations Fund V LP; $50 million to MatlinPatterson Global Advisers’s MatlinPatterson Global Opportunities III LP; and $75 million to New Mountain Capital’s New Mountain Partners III LP.