- Why this is important: System plans shift toward growth; shift in non-U.S. allocation toward China
- AUM: $27.5 bln; PE target allocation: 13 pct; actual: 13.3 pct
- Has used co-investments to reduce fees
- Wants to stay concentrated with fewer managers
- Contact for a meeting: Kelley Davenport, assistant to the executive director, firstname.lastname@example.org
Employees Retirement System of Texas approved its 2019 private equity tactical plan, earmarking $1 billion in planned commitments for the coming year and $5.6 billion in commitments over the next five years.
The $27.5 billion system has a 13 percent target allocation to PE, and it reached a 13.3 percent allocation as of June 30, after committing $612 million in the first half of 2018, according to Wesley Gipson, senior managing director for PE.
Gipson, speaking at the retirement system’s Aug. 29 meeting, said the five-year pacing plan, assuming an average 7.5 percent return in the overall portfolio, would cause the PE allocation to peak at about 14 percent.
“That private equity allocation would max out at just over 14 percent in 2020 and then glide back down to our allocation target over the next four or five years,” Gipson said.
Texas ERS is also planning to establish a direct secondaries program in private equity, a goal that was deferred from last year’s tactical plan, and shift its portfolio toward more growth-oriented funds, Gipson said.
“The only unchecked box [from 2018] is to establish our direct secondaries program, for which we’re still awaiting a headcount increase in order to execute,” Gipson said.
“And for the fiscal year 2019, we’re implementing a subtle strategy shift. We feel that we have kind of historically been — if you break up the world into value and growth — we’ve probably been a little overweight value, and as we replace names going forward, you’ll probably see a shift into growth. Part of the shift will also include a shift within our non-U.S. allocation, a stronger representation of China, which is also kind of a growth market.”
The 2019 pacing plan would be spread out over nine to 18 total commitments, enabling Texas ERS to remain fairly highly concentrated in PE, Gipson said.
Making fewer large commitments enables the retirement system to ensure that it has seats on LP advisory committees, access to information, stronger negotiating power around fees and access to co-investment opportunities, he said.
“In general, we view ourselves relative to others as fairly concentrated,” Gipson said. “We have a targeted number of relationships of around 35.”
That concentration, and co-investments in particular, has helped the retirement system reduce its overall PE fees in recent years, portfolio manager Davis Peacock said.
From 2007, when Texas ERS began investing in private equity, to 2012, the average carry it paid was 20.2 percent and average management fee was 1.7 percent. But after 2012, when the system began pursuing co-investments in earnest, the average carry dropped to 16.7 percent and average management fee dropped to 1.4 percent.
Texas ERS has made 39 coinvestments to date, with 16 unique sponsors, totaling $543.3 million. Seventy-one percent of those co-investments are allocated to buyouts, and Carlyle accounts for 19.6 percent of co-investments, diversified across two distinct strategies that focus on energy assets and financial-services buyouts.
In addition to co-investments, the retirement system has also been able to save on fees by entering into two large strategic relationships with managers focusing on secondaries and fund-of-funds strategies, Peacock said.
Texas ERS committed $600 million to those strategies in 2014, giving the system additional diversification across vintage years, with the secondaries strategy adding access to older vintage years and the fund-of-funds strategy adding access to newer post-commitment vintage years.
With the strong recent market performance, Gipson said, he had hoped to see higher distributions from the PE portfolio. But high company valuations seem to be slowing exits and causing general partners to shift their strategy, he said.
“There is lots of capital chasing fund managers, lots of capital chasing deals, no doubt,” Gipson said. “We see the impact in the number of deals that these teams are executing. They’re paying very high multiples for platform companies and they’re really trying to make up for it with many, many, many add-on acquisitions.”
The retirement system also discussed the upcoming acquisition of its private equity consultant, Pavilion, by Mercer. Pavilion told the system that things would remain more or less the same after the merger, although the Pavilion team would be able to draw on Mercer’s larger staff and bigger geographic footprint when necessary.
Action Item: Read more about Texas ERS’s 2019 PE annual tactical plan here https://bit.ly/2LWbDnz