Pennsylvania State Employees’ Retirement System has reduced its private equity target to make room for a new allocation to microcap public equities.
This comes amid a re-think of the $34.8 billion pension’s public and private equities under chief investment officer Seth Kelly, who took over last year.
At its April 28 meeting, Kelly told the investment committee that he wanted to think about equity in “totality.”
“We talk about public equity and we talk about private equity, and the only difference is public and private,” he said “They’re both equity, so when you’re thinking about it in a larger risk context, you’re thinking about equity.”
To that end, the board agreed to reduce the private equity target from 14 percent to 12 percent, with the extra 2 percent going into building the microcap stock allocation. The private equity target will have a range of plus or minus 2 percentage points.
Kelly said the goal was to “turn our equity portfolio into cash-yielding investments.”
Microcap equities are stocks in smaller public companies. According to The Motley Fool, these companies are usually valued between $50 million and $300 million. Like private equity, microcap stocks are considered risker investments. Staff told Buyouts they viewed the two asset classes as having “comparable risk.”
Kelly told the investment committee the general profile of a microcap company is often similar to a private equity company. One graphic from his presentation showed the average microcap public equity company had a $208 million average market capitalization, compared to $249 million for private equity.
At the same time, microcap stocks charge much lower management fees than private equity. They also pay regular dividends, unlike private equity.
Kelly also presented data showing the two types of equity had similar returns, according to various indexes and benchmarks.
“If your returns are similar, you’re saving money, and you’re earning a little bit of yield but we’re not betting the farm on this position, either, it seems like a reasonable thing to at least bring up,” Kelly said.
As of early March, the system’s private equity allocation stood at 13.3 percent, slightly below the 14 percent target but over the new 12 percent target, while still within the new range. The PE portfolio was valued at $4.6 billion.
Staff told Buyouts the new target allocation would be reached through reduced pacing with the new range helping to refine that calculus.
At the meeting, Kelly said it would create more “commitment discipline” for the system’s investment staff and consultants.
“I thought that was a good way of making sure that you folks know that private equity can’t grow to the moon, and it’s going to create a little more discipline for us, which I think is a good thing to do,” Kelly said.
The investment committee approved the changes. Later that day, the full board gave the changes its final approval.