Going direct

The Alberta Investment Management Company (Alberta) is changing the way it invests in private equity to take more control over its destiny.

The system is building a direct investment team that will seek out and target private equity investments in North America, and also will look to co-invest alongside private equity firms.

Alberta, which manages about C$70 billion in oil and gas assets and pension funds, has been investing in private equity through external managers for several years. The system will continue to invest in private equity as a limited partner, but will be much more selective about the managers it chooses, Alberta head Leo de Bever says.

“We'll take our time and not do anything stupid. We'll be very pragmatic about who is good and likely to create value for us, and minimise our exposure to anyone else,” de Bever tells PEI.

REGIME CHANGE
de Bever took over at Alberta in August 2008, inheriting what he describes as some underperforming private equity investments. He has a long history of leading investment programmes at various institutions such as Victorian Funds Management Corporation, an Australian superannuation fund, and the Ontario Teachers' Pension Plan.

Alberta has “traditionally been reasonably active in direct infrastructure investments”, but will start to focus on direct private equity investments that aren't related to infrastructure, de Bever says. He adds that it's looking at 10 to 12 such opportunities.

The system has commitments to private equity totaling about $2 billion, with about $1 billion drawn so far. It is seeking to invest about $1 billion over the next year to two years, though the pace could be slower depending on opportunities.

“I'm not looking to fill a bucket; I'm looking for opportunities with risk-adjusted returns,” de Bever says.

FEE ANGST
Many of the systems' past investments with private equity firms have not been performing well, yet the system is on the hook for millions of dollars in management fees. de Bever says he is working to change the cost structure of the portfolio.

“The problem I'm wrestling with right now is that 75 percent of my cost is coming from 25 percent of my assets – the externally managed assets,” de Bever says. “I'm trying to improve that cost equation. A dollar managed externally costs me nine times what it costs me internally.”

de Bever says the fee model used by private equity doesn't make sense – even if private equity investments under-perform, and no distributions from the investments are forthcoming, the system continues to pay out fees to managers.

“External managers get 2 percent no matter what,” he says. “I may be paying 4 percent every year on the amount of capital invested and get no returns in the current environment. That's a very painful way to invest, as opposed to my own guys who don't start earning any money in terms of variable compensation until the asset does at least as well as comparable public markets.

“It's a crazy situation right now, the performance standards being applied to internal managers are orders of magnitude more strict and more demanding than what we expect from external managers,” he says.

Alberta has joined other pensions in discussions with private equity firms aimed at allowing LPs to reduce commitments if the fund isn't being invested.

Alberta is also following in the footsteps of fellow Canadian pensions and systems like the Ontario Teachers Pension Plan, Ontario Municipal Employees' Retirement System and the Canadian Pension Plan Investment Board, which all have investment divisions that make direct private equity investments.

“The model is changing. The leverage LPs have over GPs is getting better,” he says. de Bever believes now is the time to invest, amid the wreckage of the financial meltdown. “People have seen the carnage and become more risk-averse. It seems like people totally misunderstand what risk is about.”