LP Radar: Tunnel vision

After a dip to -0.3 percent, returns on alternative investments in the fourth quarter of 2014 for the Pennsylvania State Employees’ Retirement System (SERS) have bounced back into positive territory.

The first quarter investment performance released at its last board meeting on 10 June 2015 showed its return on alternative investments was 2.4 percent – a welcome increase from the previous quarter. It was still less, though, than half the return rate from the year-ago period (returns in first quarter 2014 were 6.2 percent).

In this quarter, SERS generated $512 million in net-of-fees earnings, or 1.9 percent return on all investments, compared with 0.3 percent the previous quarter and 2.7 percent a year ago.

This rebound may be attributable to SERS’ efforts to increase cost-efficiency in private equity investments by making fewer commitments to top-tier managers but on a larger scale.

Last October, it committed $50 million each to Hahn & Company II and Insight Venture Partners IX funds, then another $25 million to HIG Bayside Loan Opportunity Fund IV as part of its short-term investment strategy for enhancing liquidity.


During its board meeting in March, SERS approved a commitment of up to $50 million plus other expenses to Primavera Capital Fund II, a Chinese private equity fund focused on growth equity and control-oriented investments.

SERS has repeatedly partnered with North American buyout funds, having committed to 12 TPG funds between 1997 and 2008, and nine of ABRY Partners’ funds between 1997 and 2014. Its five most recent funds, though, have all been venture capital/growth equity funds, including the aforementioned Insight IX and New Enterprise Associates 15 fund, approved in SERS’ April board meeting.

In line with its investment strategy of making fewer, larger commitments, its capital to funds since 2014 has been either $25 million or $50 million each time.

During the 10 June board meeting, the SERS Investment Committee and StepStone Group made five recommendations for future interviews in alternative investing: ADV Opportunities Fund I, an Asia-focused $500 million fund; Clearlake Capital Partners IV, a North American midcap buyout fund targeting $1 billion; HIG Brazil and Latin American Fund targeting $685 million; Lightspeed India Partners I, a $115 million venture capital fund; and Sterling Group Partners IV, a North American midcap buyout fund.

The investment committee made a recommendation at its 29 April 2015 board meeting for a future interview with Horizon Impact Fund, a customised lower-middle market private equity fund of funds with SERS as its only LP. It was unclear at the time of publication whether the board approved the recommendation at the June meeting.

These commitments are part of SERS’ strategic investment plan, for which the board approved a $600 million annual pacing for investment in illiquid assets. According to SERS spokeswoman Pamela Hile, $500 million of that amount is allotted to alternatives – private equity, special situations and venture capital – while the remaining $100 million is allotted to real assets – private energy, real estate, REITs, commodities and infrastructure.

“Our plan was designed to structure a well-diversified portfolio to meet the needs of a system that is currently underfunded, steadily maturing – has more retirees than active members – and, in the near term, will receive employer contributions below the actuarially required rate,” Hile told Private Equity International. “Those unique characteristics mean we need liquidity, low cash flow volatility and capital protection.”


Citing these needs, Hile said SERS continuously monitors fund performance, the markets and cash flows. Alternative investments let the pension fund gain exposure to opportunities unavailable in the public markets. As of 31 December 2013, the programme had committed to 337 partnerships managed by 140 GPs.

“Our alternative investments portfolio is structured to seek high, long-term capital appreciation to enhance total fund returns,” Hile said, “and therefore considers a multitude of factors with each commitment, including fund size, investment strategy, geographic focus, market dynamics, potential total fund implications.”

According to the SERS asset allocation report released at the end of the first quarter, the system allocated 11 percent of its total $27.25 billion fund, or $2.99 billion, to private equity in that period. In the previous quarter, it had allocated 11.4 percent, or $3.10 billion, and 13.2 percent, or $3.61 billion, in the year-ago period. By comparison, SERS allocated 4.9 percent of the fund to venture capital in the first quarter.

SERS’ long-term target for private equity allocation is set at 15 percent, compared with 21.8 percent, or $5.79 billion, reported at 31 January 2014. It benchmarks the Russell 3000 Index and a Custom Index for its alternative investment performance.

SERS manages $27.25 billion in assets and serves about 230,000 members. It has made more than 350 private equity fund commitments to date, totalling about $5.2 billion in capital.

At a time when LP investment strategies seem to be changing dramatically to increase efficiency, SERS is following suit. As one of the biggest statewide retirement plans in the US, it is worth watching where its investments in private equity are headed.