Friday Letter: Supersize LP

The private equity mega-pond is getting bigger, and the California Public Employees’ Retirement System (CalPERS) wants to remain a big fish within it. The California pension, according to an agenda item on its website, has agreed to commit a whopping $750 million to the latest offering from Apollo Management.  

Apollo Investment Fund VI, fundraising specialists say, is set to raise an eye-popping $10 billion. The CalPERS commitment to the partnership is its biggest private equity fund investment ever “by a long shot”, according to a pension source.

It is also part of a trend among large institutions to have higher-stakes relationships with fewer managers. According to the CalPERS note, parking this much capital with Apollo is part of an evolving strategy of “making significantly larger commitments to the best top quartile partners in the [CalPERS Alternative Investment] Program”.

CalPERS, like many public institutions, has a very small investment staff to oversee an enormous, ever-expanding private equity portfolio, both in terms of dollar value and number of GP relationships. Its many fund commitments translate into the greatest administrative burden for the investment staff.

Add to this the axiom of portfolio theory that overdiversification leads to mediocre returns. Smart LPs are instead seeking to hand as much capital as possible to what they perceive to be their best managers: CalPERS is far from alone in seeking to pare down – or at least put a cap on – the number of active general partner relationships in the portfolio.

Sensible as this may be, for the buy side as a whole it also creates problems. Seemingly every large limited partner has the same idea – put more capital with a few good funds. Access to even the latest generation of LBO funds, which includes some of the largest entities ever organized in private equity history, is therefore becoming an increasingly serious problem.

The good news (for now) is that the few good funds have more than doubled in capacity. Apollo’s Fund V, raised in 2000, drew $3.8 billion in commitments. After hitting the fundraising trail with a $6 billion Fund VI, the Leon Black-led firm decided to add a few billion to the target.

Only GP groups with great track records are able to do this, and LPs only want to make CalPERS-size commitments to such groups. Apollo, at least by its own math, fits the bill. Its current PPM lists an 85 percent partially realised IRR for Fund V. No previous Apollo fund shows less than a 20 percent IRR by this measure.

With a track record like this, a huge capital commitment is easier to justify. There certainly are other worthy GPs out there targeting smaller deals, but who’s got the time to track them? Definitely not the largest public pension funds. Smaller managers make more obvious targets for smaller dedicated private equity investors such as funds of funds. As a result, expect to see the “barbell” take on further weight at the top end of the manager spectrum.