NJ’s private equity programme emerges from uncertainty

New Jersey Division of Investment is increasing its target private equity allocation from 10.25 percent to 12 percent, effective 1 October.

The increase signals a potential end to an uncertain future for the asset class in the state, driven primarily by Governor Phil Murphy’s anti-private equity rhetoric during his 2017 campaign, multiple sources tell Private Equity International.

On the campaign trail Murphy spoke against private equity and hedge funds’ high investment fees and vowed to divest the pension funds from the two asset classes.

“These investments have cost us hundreds of millions in fees while delivering only middling results. Phil will stop this practice and ensure that pension fund dollars are put to work for the people who earned them, not for Wall Street,” his campaign website read.

Murphy took office in January 2018, and this was followed by a pause in private equity commitments, engagement with new managers and recruitment which lasted for most of fiscal year 2018 and beyond, according to a source familiar with the pension system.

The $79.5 billion New Jersey pension funds are managed by the Division of Pensions and Benefits, and the State Investment Council and Division of Investment are responsible for its allocations. Funds in the system include New Jersey’s Police and Firemen’s Retirement System, Public Employees’ Retirement System, Teachers’ Pension & Annuity Fund, State Police Retirement System, Judicial Retirement System, Prison Officers’ Pension Fund and Consolidated Police & Firemen’s Pension Fund.

“I always took Murphy’s comments as populist rhetoric that he used in the campaign,” says Thomas Byrne, former chairman of the State Investment Council. “He certainly understands private equity; he also hopefully appreciates the 17.5 percent return it generated last year.”

The $8.4 billion private equity portfolio is the top performing asset class for the New Jersey pension system, returning 17.52 percent over one year, 12.05 percent over three years, 15.46 percent over five years and 10.01 percent over 10 years as of 30 June.

But it’s certainly come at a cost. In 2018, for example, New Jersey paid out $134 million in fees and expenses for the asset class, over $60 million more than the next priciest.

However, Byrne disagrees with Governor Murphy’s statements on private equity costs: the pension system “cannot be penny-wise and pound foolish”. Otherwise, allocations to high-performing funds will be snapped up by sovereign wealth funds, he says.

“You negotiate where you have room to negotiate, and where you don’t have room you don’t. The staff did a remarkable job – they knew when to ask for something and also knew when to back off,” Byrne says.

Murphy’s law

After Murphy took office in January 2018, there was little direction from his office on the way forward.

“Let’s tiptoe before we walk, and walk before we run, and try and feel these guys out,” Byrne recalls telling the investment staff.

The first opportunity came up in May 2018, almost five months after Murphy took office: Vista Equity Partners was raising capital for Fund VII, targeting $12 billion.

Vista is an important relationship for New Jersey; it had already invested $700 million across its previous four funds. Since inception, the flagship funds have distributed $573 million to the state with a projected additional $814 million of distributions over the three-year period of 2018-20, according to pension documents.

“A private equity firm like Vista Equity Partners specializes in those niche tech sectors that you want to participate in. Yes, you can buy Microsoft, Cisco and Amazon in the public markets, but a lot of smaller firms, doing really innovative things, are growing fast and are private. So, if you want to own them you have no choice but to be in private equity,” Byrne says.

The staff recommended a $300 million commitment to Vista and there was no blowback from the governor’s office.

“That was a sign that we could do more than tip-toe now, and had come a full circle, from not wanting to anger the governor to ‘ok – the governor doesn’t seem to mind this at all’,” Byrne says.

As well as a pause on re-ups, the pension system also pulled back from new manager commitments, a source familiar with the pension system says. All commitments made last year were re-ups, the source adds.

Uncertainty was further fuelled by the departure of Christopher McDonough, director at New Jersey Division of Investment, and the decision to split the $78 billion pension system into two in July. The newly created fund, New Jersey’s Police and Firemen’s Retirement System, is set to become a $26 billion institutional investor and the 12-member board is expected to take complete control on or about 4 July.

“It may reduce our negotiating power, it may make for some administrative complications, put more burden on the staff,” Byrne says of the split.

‘Just too much happening’

One GP PEI spoke with who has a relationship with New Jersey said the changes were unsettling: there was “just too much happening” at the pension system and “no one seemed to have answers”.

“We are glad this situation was not at the time of our fundraising, but we did internally discuss New Jersey’s ability to be a reliable partner,” the GP says.

Some of the uncertainty is over: Corey Amon was confirmed as director in March and new board members don’t seem to be anti-private equity, the source familiar with the pension system said.

Governor Murphy’s deputy press secretary Matthew Saidel told PEI in a statement that “the Governor supports the objective, independent investment process followed by the State Investment Council”.

What’s more, the wording on the regulatory cap for private equity was changed to allow staff breathing room in the event a denominator effect pushed the PE allocation to beyond 12 percent. The new language clarifies that the 12 percent cap will be reviewed at the time of investments, so it is not pegged to later market volatility, the source says.

However, staffing continues to be a concern.

“GPs viewed our staff as very competent and very fair and practical in their dealings but they are also a little hamstrung, and lately shorthanded,” Byrne says.

The pension system pay-scale is low relative even to its pension system peers, and the working conditions are not the same as mid-town Manhattan. “It’s a challenge to attract and retain people,” Byrne says.

The pension system is looking to increase passive, index investing, so it’s likely some officials from the public side will transfer into private equity. While skills such as fundamental research, and industry and sector coverage will be helpful, the source said, the rest will need to be learned.