PA SERS cuts PE costs, but large PE portfolio causes concern, Novarca says

  • Assets under management: $28.8 bln
  • PE target: 16 pct
  • Actual PE commitment: $3.9 bln, or 13.7 pct
  • Key personnel: Bryan Lewis, CIO; David Felix, director Alternative Investments
  • Why this is important:  PA SERS has initiated several cost-saving measures for its alternatives portfolio

Pennsylvania State Employees’ Retirement System cut bigger checks to fewer managers to help reduce private equity fees as it worked to cut the costs of its investment program.

But the pension system’s large private equity portfolio was a cause for concern, said Marcel Straub, founding partner and chief executive of Novarca North America.

Straub spoke at the system’s Public Pension Management and Asset Investment Review Commission’s third and final informational hearing in Harrisburg Oct. 25.

The commission, a state-level body created to study investment costs, hired Novarca in June to help review Pennsylvania’s two pension funds and identify $1.5 billion in cost savings for each pension fund, Buyouts reported.

PA SERS strategies

However, “seeking relief from investment fees is a way of life at SERS,” Terri Sanchez, executive director of the pension system, told the commission in her testimony.

PA SERS’s cost-reduction strategies included a co-investment that had no fees charged on committed capital, a 35 percent reduction on invested capital management fee, and a 50 percent reduction in the GP’s carried interest, CIO Bryan Lewis told the commission in his testimony.

Additionally, investing in a no-fee sidecar vehicle reduced management fees of that investment, he said.

PA SERS also committed to first closes of PE funds that led to management-fee reductions ranging 5 to 25 basis points, Lewis said.

Further, PA SERS worked with Pennsylvania Public School Employees’ Retirement System to participate in the same investment opportunity to benefit from reduced fees, he said.

Importantly, the pension system reduced the number of PE managers it invested in and increased commitment sizes, thereby hitting certain investment thresholds to reduce management fees, Lewis said.

The pension system entered strategic partnerships with GPs to invest across products. In these partnerships, the pension system makes large commitments to the GP that are divided at an agreed-on ratio across strategies, he said.

The pension system was “working in the midst of a maturing industry where new standards are emerging and SERS is open to these standards,” Sanchez said.

Accordingly, SERS asked GPs of new investment opportunities to adopt and complete the Institutional Limited Partners Association fee-disclosure template. Effective Jan. 1, 2019, GPs with existing investments in private markets were being asked to complete the ILPA template, she said.

The system plans to hire a consultant to assess SERS’s existing systems and processes.

Novarca concerns

PA SERS had commitments in more than 350 PE funds and over 50 real estate funds as of Dec. 31, 2017, Ashby Monk, executive director of Stanford University Global Projects Center and co-founder of Novarca, said in his presentation.

“ [This is an] extremely large undertaking for Board and staff to accurately monitor and scrutinize the performance of these managers,” Monk said in his presentation.

“Such a large volume of small PE investments is rather unusual from our experience, and by definition, difficult to manage/monitor,” Straub said in his presentation.

Even though the system’s PE allocation might be smaller than the public-market allocation, the higher fees on average may cost more than the larger allocation to public equity, he said.

Selling some PE through the secondary market is a very expensive exercise due to lower secondary-market value, Straub said.

“We strongly advise such a decision be carefully reviewed before implementing,” Straub said.

PA SERS PE portfolio

PA SERS commitment sizes ranged from $75 million to $100 million to re-ups and new relationships in 2018, Buyouts reported.

New relationships included Thoma Bravo, TCV and TSG, while re-ups included Hellman & Friedman and Audax Group.

The pension system also firmed its relationship with a $75 million commitment to Hahn & Co; it previously invested in the company through its relationship with fund of funds Asia Alternatives.

PA SERS hired Fairview Capital to help reduce its noncore GP relationships over the next few years, pension documents said.

The system aimed to reduce its portfolio to about 60 core relationships, a source familiar with the pension system said.

PA SERS had a private equity allocation of $3.9 billion, or 13.7 percent, against an allocation of 16 percent.

Of this buyouts were $2.4 billion, special situations $639.8 million and venture capital $906.7 million, as of March 31, 2018.

 Action Item: Read PA SERS’s staff testimony here