US public pensions have long been a bastion of hefty private equity allocations. Now, as victims of their own success, many are turning to the secondaries market to explore ways to keep their exposure under control.

Some of these institutions have been forced perilously close to, or even above, their target allocations over the past year thanks to a confluence of factors. These include the numerator effect, caused by last year’s strong performance, and, more recently, the denominator effect, as private valuations lag their struggling counterparts in public markets.

This dynamic is being exacerbated by a congested fundraising environment, which has left many attempting to accommodate a raft of sizeable re-up opportunities at a time when internal resources and allocation constraints make doing so a challenge.

Nearly one-quarter (23 percent) of respondents to Private Equity International’s LP Perspectives 2022 Study said they were overallocated to private equity for this year, up from 13 percent in 2021 and the highest percentage since the first survey in 2018.

The LP secondaries market ground to a relative halt for much of the pandemic as volatility made it difficult for buyers to price diversified portfolios. Activity returned in the latter half of 2021 and into 2022 as LPs attempted to make room for everything hitting their desks.

“Many LPs are taking a more active approach to portfolio management, as market volatility has shifted portfolio weightings, while fund distributions have slowed,” StepStone chief executive Scott Hart said on a May earnings call.

“We believe this will create significant volume in the secondaries market as LPs seek liquidity. I wouldn’t be surprised to see some level of LP secondaries come back, and I think we’re already starting to see this in the first part of the calendar year here today.”


Number of US public pensions on this year’s GI 100 ranking

Though not a US institution, Canada’s Public Sector Pension Investment Board, for example, closed a roughly $1.5 billion sale of private equity fund stakes towards the end of the year, affiliate title Buyouts reported. Its peers down south, State Teachers Retirement System of Ohio (48 on the GI 100 ranking) and Harvard Management Company (27), also sold $1 billion-plus portfolios in 2021, while Florida Retirement System Trust Fund (28) sold more than $2 billion.


Number from the previous
year’s ranking

Such momentum carried into the first half of this year. In January, affiliate title Secondaries Investor reported that the California Public Employees’ Retirement System (8) planned to sell up to $6 billion of private equity stakes in what would be the largest-ever portfolio sale. Far from getting out of private equity, the system is understood to be shifting from a large portfolio of numerous GP relationships to more concentrated interests, separately managed accounts and co-investments after raising its exposure from 8 percent to 13 percent in November.

Houston Firefighters’ Relief and Retirement Fund is also holding its first-ever sale of stakes in private equity funds this year as it works to manage its exposure. The pension had a 32 percent actual allocation as of June 2021, with a target of 25 percent that has flexibility to extend up to 35 percent.

The price isn’t right

In part, sellers have sought to take advantage of the rich pricing in the market since last year. As of the fourth quarter, pricing came in at around 97 percent of net asset value, according to Jefferies’ full-year volume report. That is changing, however, as macro factors like inflation, supply chain disruptions, interest rate hikes and geopolitical turmoil all hammer away at the market.

During periods when public markets are moving quickly in either direction, as they have in the first half of this year, private market NAVs tend to lag underperforming rising markets and outperforming falling markets. A clear example of this was in March 2020, when stock markets fell rapidly in the early stages of the pandemic but private asset NAVs were slow to follow.

That dynamic is also an issue this year. As of April, some sellers were choosing to hold off on sales until valuation marks are set for 31 December or even 31 March 2022. “A lot of sellers have pulled processes or delayed a launch,” a secondaries adviser told Buyouts in April.

Different strokes

Of course, not every LP is approaching overallocation in the same way. Some, like the Oregon Public Employees Retirement System, are optimistic that the issue will, to some extent, resolve itself.

The $96.7 billion pension’s private equity allocation ballooned to more than 27 percent in the first quarter of 2022, making it its largest asset class exposure. While some pension systems have taken measures in response to this dynamic, Oregon said in a recent board meeting that it plans to stay the course in anticipation of private equity valuations falling in the coming months.

“We should expect those numbers to come down in the second quarter given the difference in the market environment,” said Paola Nealon, a principal at Meketa, Oregon’s investment consultant.

Others are addressing the issue by tweaking their investment policies. For example, the State of Wisconsin Investment Board (33) in March increased the range around its allocation towards private equity and debt by 5 percent in either direction to prevent it from having to sell assets to rebalance the portfolio.

SWIB has a target allocation of 12 percent to private equity and debt, though the system’s actual allocation jumped to 14 percent earlier this year as public valuations began to swing downwards while private valuations remained high.

Under its previous investment policy, SWIB was required to sell assets if its private exposure was 3 percent over its allocation limit. The fund was perilously close to having to do so, likely at a loss, Christopher Levell of NEPC, which advises SWIB, told Buyouts at the time. Extending the range to 5 percent in both directions meant the private equity and debt allocation would have to breach the 17 percent mark before mandating a sell-off.

“Expanding the range for now gives us some breathing room,” Levell said. “And lets us take an in-depth look at possible changes to policy controls later.”