Introducing Devco

The South Carolina Retirement System recently announced plans to establish an independent firm to oversee the fund’s private equity investments. The push for an in-house investment model comes as pensions across the US look to increase transparency and reduce costly fees paid to private equity firms.
In addition to approving the creation of the external management company, known as Devco, the pension has also agreed to set aside $15 million as start-up funding for the business.

South Carolina had originally anticipated creating Devco as early as 1 October, but Governor Mark Sanford and a number of top state executives requested to delay development of the firm to allow for more time to review the proposal.

The state’s $25 billion pension is believed to be the first American pension to cut out the middleman by creating its own investment firm, but Canadian pensions such as the Ontario Teachers’ Pension Plan and the Canada Pension Plan Investment Board have been investing directly for years.

At the Milken Institute Global Conference in Los Angeles in last Spring, vice president of corporate development at the Ontario Municipal Employees Retirement System Philip Haggerty told a panel that pensions in the US could benefit from direct investing, noting that Canadian pension systems had recorded annual returns of 5.3 percent over the past 10 years – compared to 3.2 percent for similar sized US pensions. “It’s now possible for us to actively promote the direct investment model,” he said. “But it’s going to take a long time for a CalPERS or a CalSTRS or a Washington State to move in that direction.”

Still, limited partners in the US have been reassessing their private equity programmes and expressing a desire for specialised direct investment accounts that do not feature the fee structures typical of traditional private equity partnerships for the past couple years. Apollo Global Management highlighted the trend in a 2009 filing with the US Securities and Exchange Commission, in which it stated an expectation to work with its investors to create more separate accounts, as investor appetite for tailor-made type funds is growing.

“Institutional investors are expressing increasing levels of interest in SMAs, since these accounts can provide investors with greater levels of transparency, liquidity and control over their investments as compared to more traditional investment funds,” Apollo said in the filing. “Consequently, we expect our [assets under management] through SMAs to continue to grow over time.”

South Carolina currently has a separately managed account with Apollo called the Apollo Palmetto Strategic Partnership. The account totals $759 million – including $750 million from the pension and $9 million from the firm – and has committed more than $250 million to investments “primarily in our European non-performing loan and private equity funds”, the firm said. The partnership gives South Carolina the option to invest directly alongside Apollo in investments, or commit capital to Apollo funds.

In May, CalPERS reached agreements with 50 investment managers to cut a total of $99 million in fees. CalPERS has been working with managers to lower fees since last year. The public pension, the largest in the US, had already reached an agreement with Apollo to cut $125 million over five years in fees and accounts the firm manages exclusively for CalPERS.

“If you look at the costs of operating a pension fund, the overwhelming majority of our expenses are investment management fees paid to private equity, hedge funds and real estate,” Joseph Dear, CalPERS chief investment officer said at a conference in April. 

In a board presentation, investment staff said CalPERS would also build up its co-investment capability to invest alongside the “highest capability” general partners to gain additional exposure to “attractive companies at lower costs”.