Skjervem bombshell: Oregon may cut PE allocation in response to managers pushing back on terms : UPDATED

  • Two managers changed terms on re-ups
  • $70 bln pension has 21 pct allocation to PE
  • CIO: “You have to draw a line in the sand”

Unfavorable terms and conditions and higher valuations on buyouts may prompt the Oregon State Treasury to reduce its allocation to private equity, the state’s chief investment officer said.

Two private-equity funds this year changed the fee or term structures on Oregon’s fund commitments to oversubscribed vehicles, CIO John Skjervem said during a panel discussion at PartnerConnect West Oct. 8 in Half Moon Bay, Calif.

“In every case it was a re-up with an existing manager,” Skjervem said. “They were oversubscribed and decided to change the terms and conditions. So, we have to at some point philosophically say, ‘We were a founder and we’re losing our founders’ fees. Or we feel strongly that director fees should be offset.’ You have to draw a line in the sand, stand up for what you believe in, and walk away.”

The Oregon Investment Council approves fund commitments after firms agree to “high level” terms and conditions such as management fees and carry, Skjervem said. Once the commitment is approved, Oregon’s investment staff irons out the more granular terms of the limited partnership agreement, which can include items such as a “founders fee” discount or an offset on directors fees paid by portfolio companies.

Failure to reach an agreement during later stage negotiations led Oregon to scrap two approved commitments, Skjervem told Buyouts.

According to Skjervem, investor demand for funds managed by top general partners has begun to outpace supply, resulting in more funds being oversubscribed. The excess demand has strengthened the bargaining position of sponsors during the later stages of the commitment process, thereby limiting Oregon’s ability to negotiate favorable terms on their commitments to certain funds.

“These are not adversarial issues, we came close. We just shook hands and said maybe next time,” Skjervem said. “We want to adhere to the underwriting principles that have been endorsed by our council, and in certain cases we weren’t able to maintain those principles throughout the negotiating process.”

If that trend continues, Oregon will likely reduce its PE allocation over the next five years. “I would just see it as a really slow fade driven by walking away from deals where terms and conditions have tightened,” Skjervem said.

The Oregon State Treasury has been active in the asset class since the early 1980s and is widely considered to be one of private equity’s most influential investors. The treasury oversees roughly $89 billion of state assets, including the $70 billion Oregon Public Employees Retirement Fund. The retirement fund had a 21 percent allocation to private equity as of August 31, slightly above its 20 percent target.

In the years following the financial crisis, limited partners were able to negotiate significant discounts to the 2 percent annual management fee and 20 percent carry model that had been used by most private equity firms. As investors developed a stronger understanding of the asset class, and the number of fund managers grew, many firms began to offer limited partners a “menu of options” on terms and fees for new funds in an effort to attract commitments, Andrea Auerbach, managing director of Cambridge Associates, said during the panel discussion.

Although many firms now offer more favorable terms to investors, Skjervem’s comments indicate that certain managers of high-demand funds are exerting considerable control over term negotiations.

“Having been in the chair two years now, I’ve seen this play out in my tenure in Oregon and it’s really happened quite quickly,” Skjervem said.

LPs are growing wary of how certain managers handle fund terms, Paul Yett, a managing director at advisor Hamilton Lane, said during the panel discussion. One of Yett’s clients, an unidentified pension system with roughly $15 billion of assets, told him that it might exit the asset class if it discovers its managers are charging it more for commitments than they charge other LPs.

The greater control certain GPs hold over their network of investors is, in part, a function of higher allocations to private equity. Competition for space under the hard-cap has given managers of oversubscribed funds more leverage in negotiating terms.

“I think that’s a function of the tremendous amount of capital that keeps coming in,” Skjervem said. “You’re seeing strategic increases to private equity allocations at the same time there is still a limited number of top performing GPs.”

(UPDATE: The story was updated to reflect a follow-up conversation with John Skjervem where he elaborated on Oregon’s investment process and its relationships with its fund managers)

(Correction: Two private-equity funds this year changed the terms and conditions on Oregon’s fund commitments. Skjervem did say three during the panel discussion but later corrected himself after the panel discussion)