Oregon State Treasury
Year entered private equity: ~1981
Investment strategy: Tends to favor buyout funds
Key officers: John D. Skjervemto, chief investment officer; Jay Fewel, senior equity investment officer
Assets under management for Oregon Public Employees Retirement Fund: $62.3 billion
Target allocation to private equity: 20 percent
Number of GP relationships: About 99
So, do you feel as though the higher target to private equity is liberating?
John: When I joined a year ago our actual allocation to private equity was 24 percent. Today we’re closer to 22 percent. The realizations have been coming in fast and furious but it’s an important nuance to differentiate between memorializing a higher target and being at the target. The new target is below where we have been for most of our recent history.
What role do the private markets play in your overall portfolio?
John: I see the role of private markets broadly defined as having two objectives. First would be diversification of returns—that ultimately we capture a return series that is somewhat different than the return series we achieve in public markets. I’m also the first to admit that that’s a nice theory, but the reality may be somewhat different. Whatever diversification we see may instead be a function of the fact that private market assets simply follow a quarterly appraisal practice and are illiquid and not marked to market in the interim, so this notion of less than perfect correlation may be a mirage. But I do believe there are investment strategies, in opportunistic buckets, that do truly have differentiated return streams and less of a perfect correlation with public equity markets. In the alternatives bucket, an example would be certain kinds of royalty streams. We’re pretty confident they offer a return series that’s largely differentiated from public markets and financial markets in general. The second objective of the private markets program—private equity, and opportunistic alternatives—is to capture excess returns through the application of skill in the form of active management.
Has private equity proven itself as an asset class?
John: An alternative asset class has to satisfy three criteria. The first is to generate excess returns that are sufficiently above and beyond fees, transaction costs and other frictional costs. You have to have that excess returns through the application of skill in active management. Criteria number two is that those net excess returns have to persist through time. Because the excess returns that don’t persist cannot be differentiated from luck. Then the third criteria, which is where we have a competitive advantage, is that we have to have access to the managers who have the skill sets and a demonstrated record of achieving excess returns that persist through time. That’s a big deal because not everyone has access. Most people think they do but in reality they don’t.
And does private equity satisfy those criteria?
John: The reality is that private equity is the most proven alternative asset class and we have the data to show it. We have 30 years of experience. We can apply in terms of those three criteria I just mentioned the most rigorous tests to private equity. Steve Kaplan of the University of Chicago and numerous others in academia have rich and robust databases to study. We can say with a high degree of confidence in private equity that there are excess returns net of fees available, and they do persist through time. I believe we’re about 20 years into that journey in real estate but that it will eventually prove itself. In the case of other alternative investments, we’re really only in the third or fourth innings where on an empirical basis we can say whether they satisfy those three criteria. If they can’t satisfy them, you’re better off investing in public equities because you’ll get median equity returns but still have liquidity. Why lock your money up for 10 years when you’re going to get a return no better than the S&P 500?
Your recent commitment pace has been $1 billion to $2 billion per year to private equity funds. With your new 20 percent target allocation, what will it be going forward?
John: It’s going to be toward the high end of that range because we now have a target that’s 400 basis points higher than the old one. It is a very imprecise science trying to hit a target because the cash flows are so lumpy. It’s futile trying to manage the actual allocation with any degree of precision. But I wouldn’t be surprised, if we continue to be in a stable, low-growth environment, with debt available and valuations reasonable—what I’d call a constructive environment—then we could quickly find ourselves in a position where we’re below that new target.
Jay: The positive cash flow in our private equity program in the last two years has been substantial but the public equity markets have rallied considerably as well. A rising tide floats all ship. While we’re getting a lot of money back, given new accounting rules some of our investments in private equity are getting written up with the passage of time as well. We look at this closely every quarter.
John: We also plan to maintain our consistency. This is integral to our secret sauce for generating high returns. The discipline they’ve shown is a terrific credit to our staff and council. We’ve demonstrated consistency and loyalty to productive relationships across vintage years. It’s that consistency, during good markets and bad markets, good and bad fundraising years, that has enabled us to put up those type of numbers. Look at pensions with less consistency in governance and staff. They tend to go from guard rail to guard rail, depending on whether the market is good or bad, and they don’t have diversification, and vintage year consistency, and their results suffer.
Jay: It is virtually impossible to time markets and private equity is no exception. That’s why you have to stay the course. If you try to bob and weave, you end up shooting yourself in the foot.
Any chance you’ll go to an even higher target allocation?
John: My view is it is unlikely to change from this higher level. The 20 percent target is as high as I would be comfortable with. When we review our asset allocations, we did model a fairly broad range for private equity, and we did look at an upper bound of 25 percent. But in terms of the likely volatility of our overall plan returns, 20 percent is really the highest level I’d be comfortable at. And we don’t apologize for that. The last time I checked the only public plan meaningfully north of that was our sister state Washington with a 25 percent target allocation.
The Oregon portfolio is fairly buyout-heavy, light on venture capital, light on funds of funds. As you look to the future, where do you see the best opportunities in private equity?
Jay: In the private equity space buyout funds are dominant in terms of size. As big as we are we have to have core relationships with those sponsors. So by definition we’re probably going to continue to have more exposure to buyouts than to other sub-categories. With regard to fund of funds, they charge an additional layer of fees. The investment council has not been enamored either with the performance of funds of funds or by the additional layer of fees charged by them. As for venture capital, it’s difficult for us to invest in venture capital when it’s no longer scalable to the size fund we typically commit to. When I worked here in the late 1980s the pension fund was just $9 billion. Now it’s $65 billion. You have to invest differently when you’re that size.
John: It’s hard enough as a public pension plan to get into the top-tier venture capital funds. Then you add in the fact that all they need is a $10 million or $20 million commitment from us. Jay doesn’t get out of bed for $20 million.
As I look over the Oregon portfolio, one thing that jumps out at me is how loyal you’ve been to firms like TPG, KKR, and Oaktree Capital, backing most or all of their funds. Do you anticipate sticking with that approach?
Jay: We try to build strategic, long-term relationships, so when sponsors are successful we stick with them. Also, if the GPs have performed as expected, when they come back to market we’re in a better position to negotiate terms. That said, we do have attrition over time due to performance, or sectors going out of favor, or key people leaving. Also, while we have core tenants of the private equity program, we do look for unique strategies that are additive to the whole portfolio. I refer to them as alpha generators.
John: There’s no magic to what it takes to get a commitment. It’s a differentiated strategy complementary to the rest of our portfolio. It’s a team of professionals that have a demonstrated record of success elsewhere and it’s an LP-friendly structure.
LPs have been in the driver’s seat when it comes to partnership terms and conditions for the last five years or so. How much progress have you made?
Jay: It’s been considerable. When I first came here, and I don’t mean to pick on KKR, but they kept all the transaction fees. We have not made a commitment to a private equity partnership since the beginning of 2011 where there isn’t a 100 percent offset. We’re getting more attractive management fees. When we come in early to a fund, we’re sometimes getting a break on carry. The pendulum has swung considerably in the direction of limited partners. Will it continue to move as rapidly as it has in the last few years? Most likely not. But the move has been considerable over the last two decades.
John: There are advantages for those of us who can write several hundred million dollar checks.
Edited and revised for clarity