San Jose plunges back into private equity

The $2.1 billion retirement system has not committed to a new fund since 2011, but plans to request proposals from private equity consultants who can guide its re-entry into the asset class later this year, said Chief Investment Officer Arn Andrews.

The portfolio currently holds stakes in six vehicles raised between 2004 and 2011, five of which are secondary or funds of funds.

Andrews, a former board member who became San Jose Federated’s CIO in March, expects the retirement system to hire a separate account manager to direct portfolio’s strategy. It will be up to that manager to decide how best to commit the pension’s assets to private equity, such as how many commitments it will make per year, whether it will focus mostly on lower-middle-market funds and the mix between buyout and venture funds.

The system may also engage the secondary market to acquire exposure to vintage years it missed, Andrews said.

San Jose Federated’s fallow period pushed its private equity allocation several points below its 9 percent target, according to pension reports. To reach its target allocation, San Jose will have to commit between $70 million and $80 million each year through the end of the decade, Andrews said.

That pace would put San Jose Federated within range of its 9 percent target by 2021, according to a recent study produced by Meketa Investment Group, the retirement system’s consultant. Andrews noted that the study is “only a roadmap; they’re not something we’re held to.”

If the city retirement system wants “to be established as a private equity program, they have to be consistent when it comes to vintage years,” Andrews said. “That being said, we have to be cognizant of where we are in terms of valuations (in PE), and we’ll be conscious of that year to year.”

“A nightmare”

Prior to Andrews’ hiring, the retirement system operated without a CIO for 18 months. More than two-thirds of its investment staff positions were vacant.

“It was a nightmare,” said Lara Druyan, a venture capitalist who sits on San Jose Federated’s board. With its investment staff stretched thin, the pension’s private equity program became an afterthought. “It was challenging to get a better strategy – and also to make new commitments – at a time when we were so thinly staffed and without a leader on the investment side,” Druyan said.

Sources attributed turnover at the system to uncompetitive staff compensation, among other factors. Former CIO Carmen Racy-Choy stepped down from her position to take a job at McMorgan & Co in 2012. In 2013, Heidi Poon, who co-led the pension’s hedge fund strategy with Daryn Miller, left to become a vice president at TorreyCove Capital Partners.

“Retention is a risk everywhere,” Andrews said. That is particularly true in Silicon Valley, where the high cost of living can pressure public investment staffers to seek higher paying positions in the private sector.

“One challenge is, if you’re looking at people out of market, they’re doing the math of buying a house in Silicon Valley and it’s not pretty,” Druyan said.

The turnover came at an especially difficult time given the strategic direction sought by San Jose Federated’s newly appointed board. In 2010, the city swapped out seats held by local officials for four public seats that were granted to individuals with professional banking or investment experience. In addition to Druyan, who founded venture consulting firm G&B Partners, San Jose Federated’s board includes executives from Intel Corp, pension consultant Milliman and financial advisory firm Carleton Burton.

The new board made its mark early, directing staff to launch a strategic allocation to hedge funds in 2011. The purpose of the hedge program was to better position the retirement system for the next downturn, Druyan said. But while the repositioning ultimately benefitted the pension, the transition – coupled with staff turnover – stunted the development of other aspects of the investment strategy, including the private equity program.

“It was not an easy time,” Druyan said. “Because it’s a relatively small allocation in the portfolio, it wasn’t our No. 1 priority.”

Revival

Recent changes at the retirement system stabilized staff turnover, which has allowed San Jose Federated to turn its focus to private equity.

Investment officers Daryn Miller and Ron Kumar, who directs San Jose’s private equity allocation, stayed with the pension in spite of its challenges through the early part of the decade. Shortly before Andrews joined San Jose Federated’s staff as CIO, the board raised the salary ranges for investment officers.

That sent “a clear message that management was concerned about retention/attraction issues and making our salary structure more competitive,” Andrews said. “They showed their professionalism by staying with the plan, and the plan’s lucky they did.”

The changes also helped attract two new investment officers: Jay Kwon, who joined from Bank of New York Mellon in 2014 to manage the pension’s investments in equities, and Brian Starr, a former analyst for the City and County of San Francisco who now leads the pension’s fixed-income portfolio.

“We’ve finally found a nice balance where we’re able to attract nice talent,” Andrews said. “This is a great opportunity we have now, regardless of what the vintage year deployment has been in the past. We’re positioned with staff, our governance structure and our consultant to really start engaging with every asset class.”

Sidebar: San Jose Police and Fire

While the San Jose Federated Retirement System stopped making new commitments in 2011, the city’s other pension, the San Jose Police and Fire Department Retirement Plan, continued to commit to new private equity and venture capital funds.

“Police and Fire, through their consultant (NEPC), still had the power to get some exposure in 2013-2014,” said San Jose Federated CIO Arn Andrews.

In 2014, San Jose Police and Fire committed $80 million across four funds, including vehicles managed by TPG Capital, CCMP Capital Partners, Industry Ventures and 57 Stars.

The retirement system had a 4.5 percent allocation to private equity as of June 30, according to an investment report.