LACERA to explore possibility of bringing co-investments in-house

Los Angeles County Employees’ Retirement Association is committing another $100 million to an external co-investment program as it weighs the pros and cons of bringing the platform in-house.

LACERA’s Board of Investments approved a $100 million commitment to Morgan Stanley at its Feb. 14 meeting, extending the life of a 12-year old platform that’s outperformed the funds in its core private equity program.

Committing another $100 million to Morgan Stanley will “ensure continued investment in co-investments, while allowing LACERA sufficient time to conduct a comprehensive review of the program. That review would include assessing the costs and benefits of managing the program internally,” a memo by the association’s investment staff says.

No formal effort to bring the co-investment program in-house is underway, LACERA staff says. But LACERA board members have asked questions about bringing certain programs in-house in the past. Granting Morgan Stanley a one-year extension provides the staff with runway to explore its options.

“It’s not really that there’s anything in motion,” one staff member said. “I don’t know if there’s anything official. But how much would it cost to have this in-house? That’s a question we’d like to have an answer to.”

Limited partners increasingly use co-investments to exert greater control over their PE holdings at reduced cost. These programs can be time-consuming and eat up a disproportionate amount of an investment staff’s resources.

New York City’s public pension system, which dwarfs the $55.6 billion LACERA manages, has yet to set up a co-investment program. California Public Employees’ Retirement System struggled to establish a presence as a co-investor after changing its PE investment strategy in 2015, according to a recent report from its consultant.

LACERA first hired Morgan Stanley to manage its co-investment program in 2006. The retirement system allocated $250 million to a separate account called GTB I, later re-upping another $300 million to GTB II in 2014.

The GTB funds are outperforming LACERA’s core portfolio of buyout funds, even with the fees and carried interest accrued by Morgan Stanley, the staff memo says.

LACERA’s core buyout portfolio was netting a 10.3 percent internal rate of return and 1.4x multiple through June 30, according to a staff memo. GTB I netted a 12.1 percent IRR and 1.9x multiple as of that date. GTB II returned a 15 percent IRR and 1.3x multiple.

“The portfolio has been successfully structured within the investment guidelines set for Morgan Stanley during the course of the program,” according to a LACERA memo. “Morgan Stanley has assembled a well-diversified portfolio as measured by vintage year, sector, geography, and general partner.”

The proposed terms on the new $100 million commitment are similar to those LACERA negotiated with Morgan Stanley on GTB II, though staff will seek to renegotiate fees where opportunities exist, the memo says.

The retirement association will pay a 0.6 percent management fee on invested capital during the fund’s first year, with further discounts applied annually, a memo included in LACERA’s meeting materials shows. LACERA will stop paying management fees in six years or whenever the fund distributes its remaining capital.

Morgan Stanley will earn 7.5 percent of the fund’s profits as carried interest, assuming the returns exceed 8 percent. Morgan Stanley’s share of carried interest jumps to 10 percent if the fund nets a 15 percent IRR or greater.

LACERA’s private equity program was valued at $5.2 billion as of Dec. 31. The retirement association is exploring a secondary sale of roughly $1.4 billion of the fund holdings in its portfolio.

Action Item: For more on LACERA, visit www.lacera.com

Signage on the Los Angeles Times building on Feb. 6, 2018. REUTERS/Mario Anzuoni