LPs eye collaborations with peers to realign PE interests

  • Why this is important: LPs seek to collaborate with peers to better align PE interests

Earlier this year, Alaska Permanent Fund, RMPI Railpen, the U.K.’s largest pension fund, and investment adviser Wafra on behalf of Public Institution for Social Security of Kuwait  launched investment firm Capital Constellation.

The partners committed $700 million to provide long-term capital to the next generation of private equity and alternatives managers. Constellation expects to deploy more than $1.5 billion in the next five years.

“Capital Constellation is an early example of the success of the collaborative concept, and I would only expect to see more such efforts going forward,” said Christopher Schelling, director of PE at Texas Municipal Retirement System.

Collaborations among LPs are on the rise, according to International Forum of Sovereign Wealth Funds’ 2017 annual review.

Partnership and cooperation among LPs are increasing, and these investments now represent almost a tenth of all sourced deals, the report said.

Group deals increasing

LPs entered 203 deals in consortiums or partnerships in 2017, up 43 percent from 142 in 2016. Solo/direct investments fell almost a third to 100 deals from 148 in 2016, the report said.

PE collaborations in 2017 climbed more than 30 percent from 2016 and nearly doubled from 2015.

The premise for the collaborative model is simple enough, said Ashby Monk, who developed the Collaborative Model with Rajiv Sharma of Stanford Global Projects Center.

It enables LPs to work with each other to build platforms, launch strategies and seed managers, Monk said.

“The current situation makes one wonder how the deployer of capital holds so much sway over the owner of that capital,” he said.

“Institutional investors end up investing in funds that are not aligned with their overall mandate. They also pay higher fees to get access to preferred managers.”

PE is a high-returning asset class in an institutional investor’s portfolio. Eighty-seven percent of LPs have seen lifetime annual returns of more than 11 percent from their PE programs, Coller Capital’s most recent PE Barometer found.

Almost 69 percent intended to maintain their current commitment paces with new PE commitments, the report said.

To get better access to co-investment opportunities, many LPs are trimming GP relationships and focusing on a few core relationships, CIOs at various institutions have told Buyouts. This has, however, sharpened competition.

Fear of missing out on their desired commitments from preferred GPs led almost 61 percent of LPs to commit to first closings of new funds. GP incentives like early-bird discounts also spurred 58 percent of LPs to commit to first closings, the Coller report said.

“Some GPs have a take-it-or-leave-it strategy, and often GPs pit one LP against the other,” Monk said.

To change the playing field, LPs are consulting each other on potential collaborations, said Daniel Adamson, managing director at Wafra.

These discussions occur at various forums, including at Fiduciary Investors Roundtable.

LPs who cannot build their internal teams because of insufficient size or governance constraints come together to discuss potential collaborations, Texas Municipal’s Schelling said.

California State Teachers’ Retirement System, Employees Retirement System of Texas, Fire and Pension Association of Colorado, New York City Comptroller’s Office, and TMRS are some institutional investors that have attended the FIRCAP roundtables.

These LPs share the advantages of deep pockets of capital, long-term horizons for investments and deep knowledge of their local markets, he said.

While no collaborations may have emerged from FIRCAP yet, conversations among LPs are the first step toward them, Adamson said. Comparing notes, exchanging ideas and sharing insights lay foundations of trust and camaraderie, he said.

Forming a partnership

A conversation with Marty Rutherford, a trustee on the board of Alaska Permanent Fund at another forum, Institutional Investors Roundtable, led to conversations that eventually led to the creation of Constellation, Wafra’s Adamson said.

Before Constellation, Alaska Permanent had numerous discussions with other LPs, but that was “hopeful ambition,” said Steve Moseley, head of private equity and special opportunities at Alaska Permanent Fund.

While those discussions did not result in a collaboration, they helped frame the strategy and negotiations for Capital Constellation, he said.

Conversations centered on three critical issues: the time frame of investments, the scale of investments and governance.

“We realized that collaborating partners had to possess distinct skills, had to be roughly the same size, and with a similar long-term vision,” Moseley said.

Moreover, a separate structure would work better than one embedded in the current team, he said.

“Keep it simple was our mantra,” Adamson said. The three investing LPs each got a seat on the board, with equal voting rights, and Wafra was designated to run the business.

It took more than a year of negotiations and discussions to finalize the partnership, Adamson said.

Action Item: Read more about Capital Constellation here: https://capitalconstellation.com/