With around £10 billion ($15 billion; €14.4 billion) of pooled assets and liabilities and a vocal interest in alternatives, the Lancashire and London Pensions Partnership (LLPP) arrives on the UK private equity scene with a thud.
The Lancashire County Pension Fund Committee (LCPF) and the London Pensions Fund Authority (LPFA) that have partnered to create the LLPP are not new to the asset class. Both have a track record of investing in alternatives, including private equity, debt and real estate.
“Alternatives are important,” Susan Martin, LPFA chief executive, told Private Equity International in July when the team-up was formally announced. “We are coming together in this partnership because we think differently.”
The LPFA has allocated 8 percent of its £4.8 billion fund to PE with a goal of raising it to 12 percent, according to PEI Research & Analytics. The LCPF, meanwhile, has diversified its £5.7 billion fund away from passively managed funds and is reviewing its allocations to direct infrastructure investments, private equity and real estate, it has been reported.
George Graham, LCPF’s director, told PEI in July that the new partnership would continue to invest in private equity “on the same scale as a combined entity but we might do it differently”.
Significantly, the LLPP is targeting more direct and co-investments. To that end, it will consider funds that can bring co-investment opportunities and will also work with investors in that fund, Graham said.
It will also wind-down existing funds of funds allocations and talk to a wider range of managers. “In PE you can play it safe and go with the big boys that give you mediocre returns or you can search out the smaller more niche funds,” Graham added.
The LLPP also expects to undertake more public and infrastructure projects that include an element of government finance. The LPFA has already tested those waters. In January, along with the Greater Manchester Pension Fund, it announced the two schemes would jointly invest £500 million in infrastructure projects over the next three to four years.
With the LLPP’s plans to pursue more direct and co-investments, it joins the growing number of UK pension funds looking to reduce costs and up returns by sidestepping general partners, their management fees and carried interest deductions.
The shift fits with the combined platform’s overall goal to reduce expenses. By pooling assets and sharing administration and liability management, the LCPF and LPFA have calculated they can save £32 million in costs over the next five years. Some of those it hopes will be in external management fees, undoubtedly including private equity.
“Pension funds are looking to reduce their total expense ratio,” said John Gripton, managing director at Capital Dynamics, referring to the measurement of costs associated with managing and operating an investment fund. “PE is the most expensive part. The market is changing and pension funds will look to do things differently.”
Poised to embark on a boosted direct and co-investment strategy, the question the LLPP faces would be the same for any limited partner: can they do it?
One placement agent speculated that the new platform aspires to follow the Canadian model, where some pension funds actively compete with general partners to secure investments. Edi Truell, newly appointed to head the LLPP advisory committee, had in his former role as LPFA chairman, reportedly high hopes to mould the fund into a version of the Ontario Teachers’ Pension Plan.
That is quite a goal. Direct and co-investments are demanding on resources. Speaking generally, Janet Brooks, managing director of Monument Group Europe, noted that limited partner co-investment requires having an investment team with a skill set in sourcing, due diligence and executing deals. “It does require far more than capital,” she said.
LPs considering co-investment opportunities should be mindful of the overall return, Brooks added. To put together a specialist team can be as expensive as paying fees on a fund.
“From a cost and control perspective, LPs want to do more co-invests and reduce capital in blind pools in the market. But an LP does have to really think that they can outperform the GPs in that market,” she said.
The structure of the LLPP is understood to still be under consideration. Martin told PEI that both funds had in-house PE expertise, but acknowledged that back office resources were a key issue in investing in private equity. A spokesperson for the LPFA declined to comment on the LLPP’s specific co-investment plans, including resources.
Irrespective of the enhanced clout the LLPP may expect to wield thanks to its size relative to other UK pension funds, it will still have to compete, like all LPs, for co-investment opportunities.
Steven Batchelor, a director at HgCapital, said that in addition to cost reduction, the trend for pension fund co-investment is driven by the ability of some of the more sophisticated funds to diversify and a desire to be active across the broader buyout market. “It is not about to evaporate, as more and more are seeking to do it,” he said.
HgCapital’s fifth fund, a £958 million vehicle launched in 2006 had inbound co-invest interest from only around half a dozen of its investors, Batchelor added. For its seventh and latest fund, a £2 billion, 2013 vehicle, that active LP interest had more than quadrupled.
One option to avoid the competition would be to receive deals on a pro-rata basis commensurate with fund commitments. This may fit the bandwidth of a thinly-staffed investment team that cannot review every transaction. Another would be to leave it in the managers’ hands. Both undermine a second key benefit of direct and co-investing – that of gaining some control over investments, and both can come with fees attached.
The LLPP’s thinking is unknown, but Gripton said: “If you are looking for co-investments opportunities you have to look at the way the GP is offering them.”
From a GPs perspective, the LLPP’s size maybe less important in any future co-investment decision than whether it can move quickly on a deal before the opportunity is snapped up by another fund. In an era of mega-fundraises where a GP’s need for additional capital from co-investors is shrinking, LPs need to be able to move even quicker.
“Size is not necessarily the right criteria,” said Gripton. “If a GP invests $1 billion and wants $200 million for co-investments and the co-investment is not delivered, then that’s a real issue in terms of the GP’s ability to do a deal.”
Under the LLPP, the two funds will remain sovereign, with the LCPF pension committee and LPFA board maintaining control of key decisions, including investment allocations. How co-investment decisions will be co-ordinated has not been revealed, but the structure suggests the two committees would have to jointly approve any opportunities that come its way as well as the mobilisation of funds. The LLPP will have to prove itself an agile investor if it is to attract co-investment offers.
Though much remains unknown about the structure of the new organisation, it does stand in the vanguard of a movement of UK local government pension authorities to combine assets to reduce costs. With that substantial pool of assets it has an opportunity to develop as the UK’s smaller answer to its more established and well-funded Canadian counterparts. Whether it is able to will rest in its ability to pick the best deals and execute quickly. And that will be a question of resources.