Transparency-Loving PSERS May Raise Target

The Pennsylvania Public School Employees’ Retirement System, known for an especially transparent style of investing, and for requiring at least a 5 percent GP commitment in most cases, could soon earmark a sizable new chunk of fresh capital for private equity. Managers of distressed debt, secondary, and international funds will have an especially good shot at it.

With roughly $7 billion already invested in private equity, PSERS is close to hitting its 11 percent target allocation to the asset class, according to Private Markets Director Charles Spiller. And, he said, that means it’s time for the $67 billion public pension fund to put more money into an asset class that provides portfolio diversification and that, more importantly, has delivered superior returns relative to public equities, fixed income and real estate.

Spiller said that he and his boss, Chief Investment Officer Alan Van Noord, plan to recommend that the board of trustees hike the target allocation in a way that creates at least $1 billion in additional private equity investments. “And we could see it going even a little higher in the long term,” he said. Like Illinois Teachers’ Retirement System and the Teacher Retirement System of Texas, PSERS would generate the dollars by reducing its commitment to public equities. “You have to take the money from somewhere,” Spiller said. “We consider private equity and public equity to each be, in effect, part of our total equity bucket.” PSERS’s target allocation for its entire equity bucket is 75 percent, or $50.2 billion, and includes U.S. and international public equities, private equity and real estate.

The additional money would let PSERS, with help from private equity adviser Portfolio Advisors, pursue a plan to become more active in the secondary market this year. “We’re doing a study of all the secondary funds that are in the marketplace today and, [while] we’re not allocating a specific percentage, I’d say we will invest in a few secondary funds this year,” Spiller said. “You’re buying positions in funds that are already existing, so the J-curve is significantly shorter.” The LP has invested in the secondary market since 1992. Given the downturn in the economy, PSERS also plans to put more capital to work in distressed-debt funds, to which the pension fund has a 3 percent target allocation. On the international front, the pension fund has roughly a quarter of its private equity pot, or $1.8 billion, in funds focused outside the United States, and Spiller would like to see that percentage grow.

Beyond that, PSERS prefers funds with diversified strategies to industry-specific vehicles. And while the pension fund doesn’t reject first-time managers out of hand, Spiller definitely wants to see that a team has worked together for a few years, whether at an investment bank or another buyout shop. Outside of the United States, the LP shies away from single-country funds, deeming them too risky. Instead it backs pan-European funds, as it did in January with a €300 million ($438 million) commitment to CVC European Equity Partners V LP, and, in 2007, with a €300 million slug to Bridgepoint Europe IV LP and a €200 million commitment to PAI Europe V LP.

An Open Book

Based in Harrisburg, Pa., PSERS is the 13th largest public pension system in the United States, serving 168,000 retired members and 264,000 active members.

During his almost 14 years with the pension fund, Spiller has helped guide the portfolio from its position as a marginal private equity player to a coveted limited partner, and developed a diversified investment strategy along the way. When he was hired, in 1994, the LP had a 2 percent allocation to private equity. A year later, with Spiller’s encouragement, the board upped it to 5 percent. The allocation jumped to 8 percent around 1998, and then the tech bubble burst.

Sensing opportunities to come in the aftermath, PSERS poured money—carving out 3 percent of its entire portfolio—into the distressed investing market in 2000 and 2001. That put the total private equity target allocation at 11 percent, where it remains. While Spiller declined to discuss specific partnerships, at that time PSERS committed capital to such distressed players as Avenue Capital Group and Oaktree Capital Management. “Initially, I’d say we were an opportunistic investor,” Spiller said, explaining that in the early days the LP was growing its program by making significant commitments to the best funds it could access, without an eye toward specific types of funds or strategies. “Today, although we are still opportunistic, we are also more strategic,” he added. The LP now has a portfolio of 161 partnerships spread across 82 general partners. “PSERS is extremely happy with the quality of the GP relationships we have,” Spiller said.

As PSERS looks to up its allocation target even more, general partners trying to join the portfolio have to brace themselves for the pension fund’s especially transparent recommendation process and a requirement—no longer as hard and fast as it once was—that they commit at least 5 percent of the fund’s value before PSERS will ante up.

The PSERS Web site furnishes a full dossier on its funds and their GPs, a practice that began in 2004. For example, on Jan. 24 the pension fund posted a resolution that PSERS commit up to $400 million to TPG Partners VI LP, an $18 billion buyout fund managed by TPG. The recommendation came at the end of a 22-page report detailing TPG’s history, the investment strategy and biographies of its leaders. On the same day, a 15-page report was posted recommending a commitment of up to $75 million to Catterton Growth Partners LP, a fund with a $300 million target aimed at small consumer brand and retail companies, managed by buyout firm Catterton Partners. “Our board considers transparency a very important issue,” Spiller said. “We are a public entity and we are subject to disclosing certain information. And our feeling is it’s better to be upfront with it and put it out there instead of waiting to answer each individual request.”

If a GP includes performance data from past vehicles in its PPM, that could also make its way onto PSERS Web site, as it did with Platinum Equity Capital Partners II LP. For example, the May 2007 resolution posted on PSERS Web site included Platinum Equity LLC’s claim that its first fund generated a 6.5x multiple of cash invested and a 291% gross IRR. “Including current investments that have not yet generated proceeds in excess of cash, Fund I has generated a 3.3x multiple of cash invested and a 133% gross IRR,” the resolution went on to say. By contrast, many public pension funds don’t post their private equity investment activities online, and many of those that do offer at most a few lines of basic information such as the fund’s name, strategy and a commitment amount.

Spiller said that PSERS has worked hard to strike a balance between transparency and a buyout firm’s need for privacy to safeguard the bottom line. In 2006, when Pennsylvania lawmakers were revising the PSERS Retirement Code Act, Spiller and his colleagues argued that information about a GP and its fund strategy was fair game, but that details about portfolio companies were off-limits. When asked, the pension fund also supplies fund performance data, such as net IRRs, which the pension fund tracks quarterly. But it doesn’t post that information online since the number of requests for the data tends to be small. The LP will, however, withhold fund performance information if “the disclosure could reveal the values of specifically identifiable remaining portfolio assets to the detriment of the alternative asset,” in accordance with Act 148 of PSERS Retirement Code.

PSERS won’t commit less than $25 million to a fund, and in most cases the LP will only commit to partnerships where the GP has invested 5 percent of its own equity in the vehicle. In fact, that was the rule for all funds backed from 1998 to 2006, and still applies in many situations, especially for emerging managers. “So if it’s a Fund I or Fund II, we would tell them they have to meet all of those requirements you see on the Web site,” Spiller said. Around 2006, Spiller convinced the trustees to grant some leeway on the 5 percent requirement for established managers, although all variations on fund terms remain subject to board approval. Spiller declined to say if there were any particular funds that inspired him to make exceptions to the policy.