Montana drops performance premium from PE benchmark

  • Montana drops S&P 1500 for MSCI USA Small Cap
  • New benchmark “investable,” better matches Montana PE holdings
  • Montana PE portfolio valued at $1.56 b

Montana Board of Investments changed the benchmark by which it measures its private equity portfolio’s performance, Executive Director David Ewer told Buyouts.

The $10.6 billion retirement system dropped its PE portfolio’s public-market benchmark, the S&P 1500 plus a four-percentage-point return premium, for the MSCI USA Small Cap index of public equities.

Private equity limited-partner systems often struggle to find adequate benchmarks for their PE portfolios. Some favor the aggregated returns of an index of private equity funds, such as those tracked and maintained by firms like State Street or Cambridge Associates.

Others, like Montana, choose to gauge their PE portfolio’s performance against an index of publicly traded stocks. With this approach, the LP will sometimes attach a premium to the public-market benchmark to account for the outperformance it expects for investing in a riskier, less liquid asset class.

Montana is trading one public-market benchmark for another and eliminating the premium. According to Ewer, the board wanted to use a benchmark that is “investable.”

While Montana could invest in the S&P 1500, there’s no investable way to generate the extra four percentage points needed to match the return it expects of its PE portfolio, Ewer said.

“Benchmarks with a premium are not investable,” he said. “Does the board want us to beat the benchmark? Does the board want a premium? Of course they do. But they think the yardstick should be: ‘If we didn’t put [money] into private equity, what would be the alternative?’”

The MSCI “is an alternative where you could say, ‘Well, at least we could do this,’” he added.

According to analysis presented to the board, the annualized return generated by the MSCI USA Small Cap index outperformed the S&P 1500 on one-year, two-year, five-year, seven-year and 10-year bases. The MSCI falls short of the long-term annualized returns generated by the S&P 1500 when a four-percentage-point premium is attached to the latter index.

“It tracks pretty closely to the S&P 1500 over the long term, let’s say over 10 years, it’s pretty close,” Ewer said. “There’s more volatility when you look at the five-year, the two-year, especially the one-year” returns.

Besides being an investable alternative, the MSCI USA Small Cap index tracks smaller companies than the S&P 1500, which makes it more comparable to the portfolio companies held by PE funds in Montana’s PE funds, board documents show.

Montana valued its private equity pool at $1.56 billion as of Feb. 28.

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