So it’s no surprise that Bruebaker, the Washington State Investment Board’s chief investment officer since 2001, has been a big fan of private equity. As Bruebaker declares, he wants all of his GPs “to become billionaires,” but not until Washington’s retirees first get their share of the private equity spoils.
Washington’s storied relationship with private equity dates back to its initial commitment to Kohlberg Kravis Roberts and Co. in 1982 (see accompanying table). Since then, Washington’s private equity program has become one of the largest and most-respected in the nation, with $24 billion in commitments and $16 billion in invested private equity capital.
More than a quarter of Washington’s main pension is now invested in private equity, a level that greatly exceeds most pensions. But complaints have been few since its private equity program has returned an average of 11.3 percent over the last decade, a period that straddles two recessions.
In a rare interview, Gregory Roth, senior editor at Buyouts, caught up with Bruebaker to find out what was on his mind.
What’s your proudest achievement?
The thing that I’m the most proud of is the team that we’ve been able to build here, which has been instrumental in building the portfolio we have today. We really have a phenomenal team, which includes 31 investment professionals with more than 500 years of collective experience. And in the 12 years I’ve been here, we’ve added to our team quite a bit because of the increased complexity and size of the assets we manage.
It seems that the market and the economy are slowly improving. Is the recovery likely to pick up speed?
I’m a little schizophrenic about the future of the economy and the market. On one hand, it’s pretty easy to see a bleak future. We have $16 trillion of debt that’s growing by $4 billion a day, along with a U.S. unemployment rate of 7.8 percent. Consumers have too much personal debt and haven’t saved enough for their retirements. And then there’s the fiscal cliff we’ll have to deal with in the very near future, and the partisan politics that have caused gridlock. Individuals and governments need to save more for the sins of the past. And corporations are worried that there just won’t be enough demand for their products so they are reluctant to hire more people.
On the other hand, I’m most worried when things are going really well—when things seem like the only place they can go is up and everybody believes that the good times are here to stay. Over the long term, however, I am cautiously optimistic. In the 34 years I’ve been doing this, I’ve seen people lose a lot of money betting against the capital markets and the United States more specifically. And corporations have more cash on their balance sheets than they’ve ever had.
I believe the capital markets will allow us to earn somewhere around 7.8 percent over the next 15 years. It’s not going to be easy, especially since I believe we are in a protracted period of low interest rates. But we are also in a period of low inflation.
We will continue to explore ways to invest where growth is, and currently that’s in emerging markets. We also like investments built around necessity items like housing and food because even when the economy is bad, people need to live somewhere and eat. And improved access to quality food, nutrition and safe water is a global story that we really like and focus on.
The bottom line is that investment turmoil leads to great investment opportunities for patient, long-term investors like the Washington State Investment Board, which have the discipline and guts to be different.
What is Washington State’s biggest lesson from the financial crisis?
The biggest lesson was that liquidity matters. The problem is that when you need liquidity, you sell what you can, not what you want, and for us, there were a few times that we sold assets when we would rather have been buying. But for the most part, we actually fared very, very well through the crisis. The problem is that when the dam’s breaking, it’s really hard to figure out that if you were to just swim in a different direction, you might actually come out quite well. In a time of crisis, your main reaction is usually to just get out of the way of the debris.
Washington State has perhaps the nation’s best-known private equity program with $16 billion in private equity capital. How much do you plan to invest in PE in 2013?
We normally put somewhere between $1.5 billion and $4 billion to work each year. We may have a year where we want to put a lot of money to work because we’re getting back a lot in distributions. But if the highest quality partners aren’t raising money that year, there’s nothing we can do about it.
Overall, our strategy is to “right-size” relationships with our existing high-quality partners, but we are always, always looking for new high-quality partners to invest with.
Have much more does your system have now because of your longstanding commitment to private equity?
Private equity has added an additional $6 billion compared to what we would have had if we had just been invested in global equities. What that means is that members, employers and taxpayers would have had to contribute about $6 billion more to our system if we didn’t have this program.
Besides a strong return history, what do you look for most with a new private equity relationship?
Clearly, you always start out by looking at their historical performance. Then we really dive deep and try to figure out whether what they’re doing now is consistent with what they’ve done in the past. What’s important is to figure out what they are going to earn with our members’ money that we’re about to commit to them. You also want to know if anything in the environment has changed. Finally, alignment of interest is the most important thing that we look at. I want every one of my GPs to become billionaires. I want them to make lots of money, but I also want to make sure they don’t make any money until my members have made their money. Most of our investments have a hurdle rate—generally about 8 percent—where we make our 8 percent first and then split whatever we make above that.
And so, we really dive down into what they’re going to invest in. We look at their plans for growth and their investment strategies. We watch carefully to make sure they haven’t had any strategy drift. But our goal is to be their favorite LP. We want to work closely with them and concentrate on things that add the most value.
Among the various flavors of private equity, where are the best opportunities?
We are not a $2 billion fund that’s like a speedboat and can change directions based on what we think the market’s going to do over the next year. Given our size, we just don’t have the ability to do that. That said, I am always looking for distressed opportunities. Always. But there are times I’ll say, Let’s try and put more to work in distressed opportunities over the next 18 months than we normally do. And there are times I’ll say, Let’s cut back on our commitments to distressed.
Joe Dear, the chief investment officer at the California Public Employees’ Retirement System, used to work at Washington State Investment Board. He told me CalPERS plans to largely get out of venture capital. Is Washington State still committed to venture?
Joe’s a very good friend of mine and I have tremendous respect for him. We still talk almost monthly. But that was Washington’s position long before it was ever CalPERS’s position.
We made this determination about three or four years ago. We had been a venture investor since 1981 and we still like venture, but due to our size, we’re never going to be able to get into the best funds because they are not going to come to Washington, sit in front of my private markets committee in an open meeting, with the press in the back, and ask Washington for money. The best of the best just aren’t going to do that.
And if you’re already excluded from the top 20 percent, it’s not a very level playing field. We will continue to invest with any top-quartile venture firms we invest with today. And if, by chance, we ever get an opportunity to invest in a top-quartile venture fund, we will invest with them. But, we’ve lowered the bottom of our venture capital allocation range to zero. We are not going to chase investments because the odds are against us.
Washington tends to commit early and commit big to new private equity funds. Do you get big discounts for being an anchor investor in new funds?
Any time we’re a large investor in a fund, we’ve gotten something for it. And anytime you see us investing early, we’re getting something out of it. One thing we get could just be a deepening of the relationship with the GP because when they have an opportunity for us to co-invest, I want to be one of the first LPs they think of. I want them to think, Let’s call Bruebaker—he was there for us when we raised the fund. We participate on the advisory committees of every relationship we can, and we send the same person to every meeting. We do that because we want to be the LP of choice. Whenever they have an innovative idea that can make money, I want to be the first LPs they think of to call.
Washington State had some incredible gains through its early relationships with KKR and others. Are such huge gains a thing of the past?
Do I think the returns we got in the past are what we’re going to get in the future? The answer is no.
Is Washington comfortable with the number of private equity relationships it has or will it seek to further concentrate its portfolio?
Back in 2002 and 2003, we concluded that we had too many GP relationships and that we were not able to develop the kind of relationships we wanted because we were spread too thin. So we started cutting back the number of relationships and identified what we call our core portfolio, which has about 42 core relationships. Not all partners were cut simply because of performance. Some may have been cut because we couldn’t put enough money to work to make a difference. Some partners may have been cut because they were doing strategies we didn’t want to employ going forward. We re-evaluate every single manager every single year to figure out whether they are still core. Every year, we’re looking to make sure that everything still fits in the portfolio and then really concentrating on those relationships.
That’s why for the last six or seven years, the amount of money we committed started increasing in the core portfolio. I love emerging markets, but funds in these places are not all created equally. When we go into these places, investment managers often have less experience, and as a result, we won’t put as much money to work with them. Even so, emerging markets are where we want to move the most money, and private markets are the slowest area to do that in.
Washington has also been a big investor lately in infrastructure funds, recently committing $250 million to Global Infrastructure Partners and another $250 million to Stonepeak. How does infrastructure fit into your objectives?
We like infrastructure. Our goal is to get a very consistent, long-term stream of income. We are not looking for private equity returns, but rather fixed income-like returns, but we want more protection from inflation and we want more income.
Several pensions, including Texas Teachers, New Jersey and CalPERS, have invested in large, separate accounts. Is this something Washington State is also considering?
We’re always considering any way to deepen our relationships with general partners. We have strategic relationships with these GPs and work very closely with them to try and shape the alignment of interests, which is the most important thing for us. So we are always exploring ways to further align our interests with our investment partners. These strategic relationships are clearly a step in the right direction. But the types of strategic relationships that have so far been established are not quite what I think is right for Washington State.
Have there been specific negotiations? What do you think about the other separate account arrangements that have been struck at Texas Teachers and New Jersey?
There have been specific negotiations. At the end of the day, the alignment of interests is how we’re going to best serve our members, to make sure that our partners have all the latitude they need to make us money, but that our partners only make money after my members make money.
I think the world of Brett Harris (of Texas Teachers). He’s extremely intelligent. But as I understand his strategy, KKR and Apollo Global Management actually have a fair amount of latitude about where that money gets put to work. To me, that’s outsourcing asset allocation to an investment manager that may have different interests than I do. So that’s not something I would do.
There are several underfunded pensions that are just now starting to invest more heavily in private equity. Are they are late to the party?
I don’t know. It also depends on what resources they put behind their efforts. In my view, in the next 30 years, they’re not going to get the same kind of return that they would have had during the last 30 years. That’s not to say that they won’t get a risk-adjusted return that justifies investing in private equity. But I think the median return in private equity for the next 30 years probably will not be a risk-adjusted return that would warrant investing in the asset class. It’s sort of like Lake Wobegon—we all think we’re above average. And we clearly are. Our 10-year and 20-year performance is in the top decile. So, we have the demonstrated skills to pick managers that are better than the median, but half the players are not going to be able to do that, by definition.
What is your opinion of placement agents? Do they provide a valuable service for pensions like Washington State?
I don’t really understand the whole issue around placement agents. And what I’m about to tell you is Gary Bruebaker’s opinion and not necessarily the opinion of the Washington State Investment Board because we haven’t had any issues with placement agents. In some states, including New York and New Mexico, some people broke the law. They did bad things. So, the fullest extent of the law should be thrown at these people. But it had nothing to do with placement agents, specifically. In a pension like ours, there is no one individual who’s ever going to get my board to invest in a fund. It doesn’t matter who they are. No one individual could ever have that kind of influence over the board or staff.
Is it hard to find qualified people given the limits on what you can pay your investment employees?
Yeah, recruitment’s really tough for us and at times it can take us years to hire a position. And the reason is that we want top-quartile performance. But by statute, we can only pay “average” because our pay, by law, is the average for funds of our size. So, the bottom line is that we want the best of the best and we’re willing to pay you average for it. How do we get good people? Well, the WSIB is a great place to work, and for the right people, Washington represents a true quality-of-life option. I believe we offer a real work-life balance, along with excellent opportunity for professional growth. So we work really hard to get people with the right skills and the right attitude who will thrive in the government structure we have here. We want people who care more about making a difference than about making the most money they can, because if it’s about the money, they’re not gonna come to work for us anyway. So, while it takes us longer to recruit, we’ve been pretty successful at retaining people because we work so hard at hiring the right people, and honestly, this really is a great place to work.
What do you wish GPs better understood about investing with Washington State?
Let me tell you about what they do understand. They understand we have a demonstrated track record of sticking with our GPs even when others are cutting back. If our general partners deliver on a promise, we are there for them, and they understand that. It’s amazing that there are highly respected GPs we have never invested with who work hard because they want to add our name to their roster of investors.
Finally, what keeps you up at night?
I take this job very seriously, since I have an obligation to more than 400,000 public employees to do everything I can to secure their financial future. So, the biggest thing that keeps me awake at night is what if we don’t earn that 7.8 percent over the next 15 years? What if I only earn 6 percent? Even if I do the best job I can, if the most I can earn is 6 percent, instead of the 7.8 percent they are counting on, what happens?
My father always used to tell me that, At the end of the day, all you have is your good name. The thing I’ve learned in the 34 years I’ve been in business is that reputation is gained in inches per year and it’s lost in feet per second. So I worry that something could go wrong that could really set us back. So we really work hard here to protect our reputation.
Edited for clarity