Inside PSERS’ co-investment programme

Pennsylvania Public School Employees’ Retirement System staff intends to ask its board to approve higher commitment amounts for its $666 million co-investment programme because the “proof of concept” has worked well for the pension system, according to chief investment officer James Grossman.

Speaking at the 10 October board meeting, Grossman did not reveal the amount of co-investment approval staff would seek or when, but the board last approved cheques of up to $25 million for co-investments in December 2017, up from the $15 million rate in place since the programme’s inception in 2012.

PSERS’ co-investment programme had 44 active investments and had exited 10 as of 10 October, according to senior investment manager Tony Meadows, who gave a presentation on the programme at the meeting.

All PSERS co-investments were pegged into a Fund I or Fund II bucket to demonstrate what the co-investment programme would look like if PSERS were a fund manager, according to Meadows’ presentation. Fund I had investments made between 2012 and 2017 averaging $11 million, and Fund II was comprised of transactions made post-December 2017 with an average commitment of $13 million.

PSERS has committed $153 million to eight co-investments to date in 2019, with an average of $19 million per deal, Meadows said.

Fund I had six realisations, and the co-investment named PEP #13 (the pension system has an anonymous naming convention for its co-investments) was “our biggest home-run to date so far”, Meadows said, noting that the co-investment generated an additional $500,000.

Fund I was generating an internal rate of return of 25.3 percent and a multiple on capital of 1.97x, while Fund II was generating an IRR of 14.3 percent and MoC of 1.1x as of 31 December. Overall, the co-investment programme was generating an IRR of 24.2 percent and a MoC of 1.56x as of 31 December, Meadows’ presentation said.

Fund I would be a top-quartile fund, while Fund II would be second quartile, “but I’ll kind of excuse it because it is still young”, Meadows said.

The co-investment programme has generated the highest returns since inception compared with other private equity strategies. It returned 10.06 percent over one year, 18.11 percent over three years, 20.96 percent over five years and 23.82 percent since inception as of 31 December. The private equity portfolio, comprising large buyouts, mid-market buyouts, secondaries and the co-investment programme, returned 8.83 percent over one year, 14.10 percent over three years, 8.87 percent over five years and 11.85 percent since inception in the same period.

Commitment to co-investments

Since inception, the PSERS staff has reviewed 125 co-investments; 62 were declined after due diligence and eight were declined by PSERS’ Allocation Implementation Committee (AIC), which is chaired by deputy chief investment officer Charles Spiller and made up of chief investment officer James Grossman, deputy chief investment officer for public markets Tom Bauer, senior portfolio manager for absolute returns Bob Liddle and managing director of investment operations John Kemp. One transaction approved by the AIC was declined by the GP on legal terms.

“A lot of GPs don’t realise we are serious about co-investments,” Meadows said. “They kind of nod their head until I start telling them about our 54 co-investments and the capital deployed, and all of a sudden they start to write it down. ‘Oh they are serious and they are going to be a willing LP to offer a co-investment to.’ So it’s a nice give and take.”

Co-investments offer an opportunity for additional diligence on managers; PSERS is given access to slide decks and management presentations and can talk to or meet the deal partner on specific transactions, according to director of private markets and co-investments Darren Foreman.

“We can think of two GPs we are not going to re-up with because they were below standards,” Foreman said, referring to information gleaned during co-investment due diligence.

Co-investment partners

Transactions came through 20 GPs, 16 of which had given PSERS multiple co-investments, demonstrating the good relationship the pension system has with the manager, according to Meadows.

Bridgepoint, which owns PEI Media, had shown PSERS the maximum number of co-investment deals. Milestone Partners, Incline Equity Partners and Catterton Partners were other firms that had offered PSERS co-investments in the mid-cap space.

“In general, the big funds, the ones that are public on Wall Street, I don’t like the massive funds just because the opportunity set is not right,” Foreman said, adding that public-to-private transactions aren’t always smooth, and on exit, private equity firms must often go back to the public market or look to sell to a big corporation.

In contrast, smaller funds sell upstream to these big firms, so they have that “extra mobility”, Foreman said.

Not all co-investments have delivered for PSERS. “There are some we have missed on, but they haven’t been realised yet and so the hope is they are going to come back and at least return our money,” Meadows said.

“That is very minimal. I’m talking less than a handful of co-investments.‘’