New Mexico SIC votes against Dyal commitment

The New Mexico State Investment Councilrejected a $75 million commitment to Dyal Capital Partners’ third fund.

Although the commitment was recommended by its investment staff and consultants, the council voted down the commitment six to three, according to a video of its February 23 meeting.

But even without the commitment, Dyal is well on its way to hitting its target. The subsidiary of asset manager Neuberger Berman has raised $1.5 billion toward the $2.5 billion target for Fund III, Neuberger Berman Managing Director Michael Rees said in the meeting.

Dyal has an unusual investment strategy: It buys minority stakes in private equity management companies. The firm is a partial owner of Vista Equity Partners and Providence Equity Partners, which entitles Dyal to a share of the management fees and carried interest generated by those firms’ investment funds.

Dyal III’s unique strategy won the support of blue chip LPs like Alaska and the New Jersey Division of Investment, but New Mexico’s investment council faulted the vehicle for a variety of issues.

Council member Linda Eitzen led the SIC’s opposition to Dyal III, citing concerns with its indefinite fund life, fees, performance and risk profile. As a minority shareholder in private equity firms, Fund III investments will have few clear paths to exit, Eitzen said in the meeting. That problem is compounded by the vehicle’s indefinite fund life, which could leave LPs on the hook for Fund III’s 1.5 percent management fee for a long time.

Alaska documents indicate the firm can exit its ownership stakes via initial public offerings, secondary sales, tender offers and dividend recaps.

Furthermore, Dyal’s investment strategy may create succession issues by motivating founders of the firms in their portfolio to cash out, Eitzen said. “The investment from Dyal is providing the liquidity to buy those partners out,” she said. “So the [firms] they’re buying could be very different over the period of their ownership.”

Eitzen, citing a memo by advisor LP Capital Partners, also noted Dyal’s first fund netted its LPs an 8 percent internal rate of return while grossing 22 percent. Another source pegged Fund I’s net IRR at 13 percent and gross IRR at 25.9 percent, attributing the spread between gross and net to the J-curve.

While it did not commit to Dyal, New Mexico did approve a $100 million commitment to Vista’s sixth fund at the meeting, which remains subject to final negotiations. Had the SIC approved a commitment to Dyal, a portion of the management fees paid to Vista VI would’ve come back to the sovereign wealth fund as Dyal III fund returns.

In the meeting, Rees paraphrased an LP who called Dyal’s strategy the private equity equivalent to owning shares of Apple. “Damn, I hate paying that much for my iPad, but I love owning Apple stock,” he said.

Dyal could potentially raise an additional $2.5 billion in co-investment capital, according to Alaska Permanent Fund documents.

Action Item: For a link to a video of New Mexico’s SIC meeting, visit http://bit.ly/1Qssw59