As one of the giants among the US public retirement funds – 47th in Private Equity International’s LP 50 ranking of the world’s largest private equity investors – the New York State Teachers' Retirement System’s exposure to private equity is varied and plentiful.
The $110 billion pension system, which has 426,000 members, first dipped its toe in the private equity pond in 1984, but it was another 15 years before it officially committed to investing in the asset class. In 1999 its PE allocation target was just 1 percent. As of 30 June this year it sat at 7.7 percent – slightly higher than its 7 percent target, but within its designated 4-12 percent range.
The $8.3 billion private equity programme has interests in growth, venture capital, secondary, mezzanine, distressed, special situation and real estate funds, but its biggest exposure is in leveraged buyouts, to which it dedicated half of its PE assets as of 30 June. Funds of funds ranked second in private equity allocations at 16 percent, followed by co-investments (11 percent).
However, according to its latest annual report, that could all be set to change. NYSTRS is in the process of moving away from large and mega buyouts and is seeking greater exposure to small and medium buyouts in North America and Europe, as well as to sector-focused funds and mid-sized distressed and turnaround managers. The system is also looking to “supplement its venture portfolio through selective commitments to growth strategies”.
In making this shift, NYSTRS is following in the footsteps of a number of other LPs and even GPs amid near-record highs of purchase price multiples in the market, Antoine Drean, chairman of fund advisor Triago and founder of online marketplace Palico, tells PEI.
“[The middle market] is more vast, populated by lesser-known companies, and more opaque than the large buyout market, so investors believe their chances of finding relative bargains is higher,” Drean says.
Placement agent Monument Group’s partner John McCormick does not find it surprising that LPs are looking to the middle market, citing their search for greater returns in the space with more companies and deals to look at.
“We are seeing these larger investors get creative in accessing smaller-sized funds, either through separate accounts or via co-investment vehicles, as one of the challenges they face is gaining sufficient scale in their allocations to these smaller funds,” McCormick tells PEI, adding that he does not expect a complete shift to the smaller funds. “I do believe they’ll continue to be loyal to their larger relationships while they look to add exposure to the lower middle-market space.”
NYSTRS’ instinct to gravitate toward smaller and more specialised managers chimes with both anecdotal evidence and hard data. According to a Cambridge Associates study in 2014 analysing investments made over the 10-year period from 2001 to 2010, sector-focused funds generated a multiple of invested capital of 2.2 and a gross internal rate of return (IRR) of 23.2 percent. Generalist managers, on the other hand, returned an aggregate 1.9x and a 17.5 percent gross IRR.
A study from Swiss manager Adveq and London Business School’s Coller Institute, which took US data collected from the US Securities and Exchange Commission filings for more than 3,800 advisors of private equity funds and combined it with performance data from Preqin, backed these numbers. Its sample of 407 US-based fund managers, found that larger managers who tend to have diversified away from private equity deliver poorer performance.
US-based firms with more than $5 billion in assets under management (AUM) had, on average, 36 percent of assets dedicated to private equity, while those with $500 million-$1 billion of assets had 63 percent, the study found. Those with more than 50 percent of their AUM in private equity on average delivered a return of more than 9.5 percent per year after fees, while those with less than half of their AUM dedicated to the asset class delivered 8.2 percent.
According to its annual reports, in the fiscal year ended 30 June, NYSTRS committed $1 billion in capital to new and existing private equity funds, taking home distributions of $2.3 billion from existing investments.
It made 15 new commitments to private equity funds in that period. Among them was €100 million to Rhone Partners V, which closed on $2.6 billion, a $70 million investment in Thoma Bravo Special Opportunities Fund II, which closed just over $1 billion, and a €70 million commitment to the €3 billion ICG Europe VI.
NYSTRS made five commitments to private equity funds in Q3 2015, several of which bear out its new proactive approach toward smaller managers. Its investments include a commitment of $50 million to Clearlake Opportunities Partners, which is seeking $500 million for minority investments, and A$135 million ($94.9 million; €88.5 million) to Pacific Equity Partners Fund V, which closed on its A$2.1bn hard-cap in September. The system also committed £50 million ($75.6 million; €105.8 million) to UK-based Phoenix Equity Partners 2015, which is seeking £500 million according to PEI Research & Analytics.
In the 10 years leading up to 30 June, NYSTRS’ private equity programme returned 13.2 percent, exceeding the benchmark consisting of S&P 500 plus 500 basis points, which returned 12.9 percent.