LP appetite for buyout funds remains solid for most

Limited partners are flush with cash in 2007, and they appear particularly drawn to invest in small funds, mega-funds and emerging managers, according to an informal survey by Buyouts, a PE Week sister publication.

However, a few LPs say that they are close to being tapped out—not surprising given the record $355 billion in commitments that investors have made to U.S.-based buyout funds in the last two years. How much appetite those few have for partnerships in 2007 will partly depend on how much money they get back in distributions. Those were some of the themes that emerged from interviews with 17 limited partners, including state and local pensions, fund-of-funds managers, a family office and a number of placement agents.

One LP said that it would cut back its commitments to buyout funds this year due to zealous investing in 2005 and 2006. “Our allocation [to buyout funds] will be lower than it’s been in the last two years, but I need to clarify the fact that the last two years were way out of the norm on the high side,” said Jeffrey Horvitz, vice chairman of family investment office Moreland Management Co. More than half of Moreland Management’s investment portfolio consists of private equity funds, and many of those are managed by U.S. buyout firms. Horvitz declined to site dollar amounts.

“We are seeing a lot of re-ups—firms we are already invested in, and that we would like to stay with—that have spent their money so fast, returned none of it, and are already back in the [fund-raising] market,” Horvitz said. “It’s difficult to see what further commitments we could make.”

Needless to say, all is not gloom and doom for fund-raisers this year. Based on his assessment of LPs, Kelly DePonte, a partner at placement agent Probitas Partners, said that 2007 fund-raising could even trump 2006.

For every LP feeling sated, new ones are springing up, ready to take their place at the banquet. Relatively new entrants to the asset class include Employees Retirement System of Texas and Arizona State Retirement System. Outside of the United States, QIC of Queensland, of Australia, has become active, while The Norwegian Government Pension Plan—the largest in Europe—is considering an allocation to private equity. Other investors abroad that have shown interest in the past year are British Columbia Management Co., The Canadian Pension Plan, National Pensions Reserve Fund of Ireland and Korean National Pension Service.

And plenty of investors remain just as active as they’ve ever been, if not more so. Among long-time investors Allstate, Teachers Retirement System of Illinois and Indiana Public Employees Retirement Fund are all expected to be active this year. Peter Keehn, head of alternative investments at Allstate, said that the insurance company committed the amount of money it had intended to last year, when buyout funds made up 60% to 70% of its portfolio. This year, he said, Allstate plans to commit between $600 million and $650 million to between 15 and 20 funds.

TRS Illinois in the midst of an expansion plan. The pension just recently bumped up its allocation to alternative investments to 8% from 6%, which will move its commitment target to $800 million per year, up from the $630 million it committed in fiscal 2006, which ended June 30. The pension fund also decided to make its overall portfolio more buyout-heavy under the direction of advisor Pacific Corporate Group. In the past year, TRS Illinois raised its buyout allocation from 45% to up to a range of 60% to 70% of its alternatives portfolio; it reduced its target venture capital exposure from 35% to 10% to 20 percent. It also slightly reduced its target exposure to mezzanine and distressed funds.

Here is a summary of 2007 commitment plans of other LPs.

Charles van Horne, a managing director at fund-of-funds manager Abbott Capital, said the firm plans to commit about $1 billion to private equity in 2007, the same as last year.

• Expect the 2007 commitment pace to private equity funds at fund-of-funds manager Hamilton Lane to be about the same as last year’s. The firm has about $8 billion in discretionary assets under management that can be deployed in slugs ranging in size from $3 million to $500 million. LPs that Hamilton Lane advises “are tweaking things at the edges [of their allocation targets], but buyouts is such a long-term asset class that it’s hard to make any really dramatic changes,” said Managing Director Michael Kelly. “We’re still going to put a significant amount in buyouts relative to the rest of private equity.”

• Fund-of-funds manager Peppertree Partners plans to commit between $15 million and $40 million in total to three to seven funds. Last year it committed $15 million in total.

American Beacon Funds, the corporate pension plan for American Airlines, plans to commit between $50 million and $300 million to private equity, with buyout fund commitments accounting for up to 80% of committed funds. The firm plans to commit from seven to 10 funds in 2007.

• Fund-of-funds manager Drum Capital Management plans to commit about $500 million to distressed funds this year, some of which will have control-oriented strategies. Its latest fund, Drum Special Situations Partners II, is expected to close in the second quarter.

San Francisco Employees’ Retirement System, plans to commit $250 million to buyouts this year, on par with last year’s pace. It plans to back about 10 funds, including between two and four sponsored by emerging mangers.

California State Teachers’ Retirement System plans to maintain its 2006 pace by committing some $6 billion to buyout funds.

• Funds-of-funds manager RCP Advisors believes smaller funds generate the best returns in the buyout market, and the smaller the better. This year the firm plans to reduce its exposure to funds sized between $600 million and $1 billion, and raise its exposure to smaller funds by committing to funds with an average size of between $350 million to $400 million. RCP Managing Principal Tom Danis said that his firm plans to commit to 12 to 15 funds this year with its latest $300 million fund of funds.

Phil Shaw, a managing director at fund-of-funds manager Invesco Private Capital, said that his firm also likes to back small funds. Invesco, which last year committed $250 million to private equity, plans to commit between $200 million and $250 million this year in the industry, with up to $175 million going to buyouts. About two thirds of the latter amount will go towards smaller buyout funds. “We still like the inefficiency” in the smaller markets, Shaw said. “Smaller fund sizes potentially give us a shot at better returns. We’re nervous of bigger funds because of the more efficient prices and tendency for there to be more syndication, which can lead to too much concentration in a single investment or market.”

• Fund-of-funds manager Siguler Guff & Co. is another firm that’s looking to back small funds. It is trying to raise $400 million for Siguler Guff Small Buyout Opportunities Fund, which would be committed over the next few years in funds of less than $250 million.

Grove Street Advisors, which has made a specialty of backing emerging managers, committed $430 million to private equity funds last year, half of which went to buyout funds. This year, half of its $500 million aimed at private equity is earmarked for LBO firms. Grove Street plans to back about 15 funds, placing between $5 million and $75 million in each. It recently backed ex-Sierra Ventures pro Jeff Drazan’s inaugural fund, Bertram Capital. “We love new and emerging teams,” said Catherine Crockett, founder of Grove Street, which plans to commit about $250 million to buyout funds this year. “We like to be the first investor. Investment bankers, executive search guys, they know we like to look at things when they are really raw.”

• One of the largest contributors of capital to the asset class, California Public Employees’ Retirement System (CalPERS), stands about $900 million shy of the mid-range of its target allocation for alternative investments—including buyout funds—of 6%, or about $13.5 billion. As of Oct. 31, the pension fund had about $12.6 billion of its capital already invested in the market. CalPERS does have the option to increase its investments in alternatives to as much as 9% of its $225 billion under management. It can also go as low as 3%. In addition, it’s unclear how much CalPERS plans to commit to LBO funds this year.

A version of this story appeared previously in Buyouts, a PE Week sister publication.