LP Radar: Cleaning house

In January, news broke that the Pennsylvania Public School Employees’ Retirement System (PSERS) had agreed to sell a significant chunk of its private equity portfolio on the secondary market. Ardian, Goldman Sachs Asset Management and Deutsche Bank all bought pieces of PSERS’s portfolio in an auction which was led by secondaries advisory firm Cogent Partners. The sale was notable as it highlighted the ongoing trend within state pension systems to simplify their sprawling portfolios and refocus core objectives.

Commenting on the sale, PSERS spokeswoman Evelyn Tatkovski Williams told Private Equity International that the aim behind the deal had been to address over-allocation to private equity, and that it had been looking for an appropriate time to bring the portfolio more in line with its target allocation. “We believed it was a good time to sell based on the strength in the equity markets and depth of the secondary markets. The portfolio that was sold was non-strategic/non-core and included some older and newer partnerships. By selling these non-strategic partnerships PSERS staff is able to focus its efforts more on the remaining strategic partnerships.”

Specifically, PSERS had been working to bring its private equity exposure back in line with its 15 percent allocation target. That meant selling off 20 limited partnership interests with a total net asset value (NAV) of approximately $2 billion as of June 30, 2014.

The three sales, which in aggregate represented approximately 20 percent of PSERS’ total private markets allocation, reduced the fund’s allocation to private equity from approximately 20 percent to approximately 16.5 percent. The pension says it could take a few years before it ultimately gets down to 15 percent.

Some of the proceeds from the auction will go to increase the portfolio’s allocation to public equities – a move similar to what CalPERS has been doing as part of its multi-year portfolio de-risking strategy, which has included dropping hedge funds entirely.
When pension plans sell their illiquid holdings, critics are often quick to point out that they really shouldn’t be in the riskier and more expensive alternative asset classes in the first place, and are thus being prudent by unwinding these parts of the portfolio. (CalPERS was lauded for its decision to close its hedge fund programme and has subsequently been cited as an example worth following in statements by other pensions that also opted to get out, including most recently €152 billion Dutch healthcare pensions manager PFZW.)

However, it is worth noting that PSERS and other recent sellers like it aren’t seeking to quit private equity altogether. So perhaps a better way of interpreting the increase in pension plans using the secondary market to adjust their private equity positions is to see it as confirmation that active portfolio management has become genuinely viable and is widely practised. Late last year, Montana’s state pension system lauded its success in using the secondaries market to slim down and refocus its private equity portfolio back on core strategies.

On the buy side, specialist secondary acquires such as Ardian have staked their track record at least in part on these types of sales. In a statement released following the auction, Ardian pointed out that it was the second largest transaction of its kind in 2014, and that its appetite for buying sizeable bundles of limited partnership stakes pensions was undiminished. “Our focus tends to be on larger deals with quality assets where we can achieve a good outcome for both sides,” said Mark Benedetti, a managing director in the firm’s funds of funds business.

Last April, Ardian closed its latest secondaries fund on a $9 billion fundraise, one of the largest pools of secondary capital ever organised. Ironically perhaps, a significant portion of the capital this fund would have come from US pension plan LPs.
Pension investors are often criticised for investing at the top of a market, or letting slow and bureaucratic boards send money into markets at the wrong time. But over the past few years, in private equity certainly, pension schemes undoubtedly have been getting savvier. Moves to reduce GP relationships down to core strategies, alongside a growing interest in co-investment and other types of direct engagement are widely expected to have a positive effect on investment performance, and hence deliver welcome relief to individual pensioners.

The secondaries market has been benefitting enormously from LPs consolidating their holdings. In terms of deals closed, 2014 was a record year with nearly $33 billion of fund interests changing hands, according to NYPPEX Private Markets. Market insiders expect strong deal flow to continue.

Primary GPs have something to gain also. Over the longer term, pension funds that are more stable overall will be more inclined to make new commitments, both to those managers that have survived the cull and also new relationships.