How Illinois Municipal designed its PE programme around its constraints

Private equity must outperform all other strategies for the pension plan to reach its assumed rate of return, says chief investment officer Dhvani Shah.

The $42.76 billion Illinois Municipal Retirement Fund’s private equity holdings account for more than 89 percent of the pension plan’s $4.18 billion alternatives portfolio, including funded and unfunded commitments, and has generated the best returns among all alternatives since inception.

Chief investment officer Dhvani Shah spoke to Private Equity International about Illinois’ PE strategy and plans.

What is the strategy for Illinois’ private equity portfolio?

Private equity has to outperform all other strategies for us to realise our assumed rate of return of 7.25 percent. Based on capital market assumptions, other asset classes will help us realise 6.8 percent: alternatives have to plug that gap.

The private equity strategy at Illinois has evolved since inception in 1984. In 1999, we established fund-of-one relationships with Abbott and Pantheon to allocate capital in private equity. When I joined in December 2011, I initiated the direct programme to invest in buyouts, venture capital, special situations and private credit strategies. Predominantly these investments were meant to be opportunistic and depended on our portfolio construction needs; the average commitment size is $36.5 million across all private equity strategies.

First we committed only to US-focused funds, then added a bit of Europe and Asia in our portfolio.

Last year we added another two separate managed accounts with HarbourVest and Goldman Sachs to further expand our portfolio.

How does the mix of SMAs and direct investments help Illinois Municipal?

Our portfolio and team construction had to consider our governance structure. We have five or six investment committee meetings every year and take back each recommendation to them for approval. In addition, we have a 15 percent minority-manager allocation, according to the Illinois Pension Code. [Such firms must be 51 percent or more owned by minorities, women, or people with a disability, according to the Illinois Code.]

On the private equity fund side there are pre-marketing and fundraising cycles. We are careful in mapping out our work, conducting due diligence and preparing recommendations according to those investment committee dates. But our SMAs are always active and can deploy capital to the best opportunities. There is no limit set on how much they can allocate to each strategy.

We might all commit to the same fund, but that is not a problem, except that our direct commitments will typically be of a higher amount. Through our direct programme we are not trying to outperform SMAs. We are trying to outperform. Period.

What makes Illinois Municipal a partner of choice?

We are selective and have only about 23 GPs in our direct investment programme. When I tell a GP that they are one of less than 30 GPs, not 300 GPs, in our portfolio, they know they are in exclusive company. I am not going to grow this into a 200 GP portfolio and then say, “Oops I can’t manage it”. The GP knows we are a long-term investor with strong organisational governance. Our funding status is strong, our board is ex-officio, they are elected for a five-year term and we are consistent.

Besides, we have a deal team approach. In the direct investment programme, of the four investment professionals, at least two staff members know the GP. That alleviates GP concerns of having to re-establish relationships with the pension system in case their contact person leaves. More staff know all the GPs, so we are reducing that risk.

We also have an open-door policy and take meetings when requested. Yet, it is not only about the meetings – we know the landscape well and are cognisant of the changes in it.

Does Illinois commit to co-investments and secondaries?

We are highly selective; [we] have committed $65 million to co-investments to date with our existing GPs and have committed another $100 million to a GP-led global co-investment fund. I know the portfolios, teams and processes of my GPs, so a lot of that learning curve does not exist.

When a co-investment comes up, we already know the motivation and manage to get everything done within the investment committee timelines. If I had to do $500 million and manage 200 GPs, that would be a totally different thing.

As of now we haven’t done secondaries because our focus is the primary funds market, selective co-investments and only in special cases will I think about secondaries. We could always invest in them through our SMAs or take something to the board if it was compelling enough. Right now though, we have a mature portfolio, we are deploying new capital in primary funds, the old ones are being harvested and we don’t have a cashflow or J-curve mitigation problem.

What trends are you seeing?  

GP-led secondaries and permanent capital vehicles are the new strategies in the market now, but it is too early to predict how these will pan out. For instance, in the permanent capital vehicles, how will GPs monetise their commitment stakes?