Texas Municipal: ‘We don’t make tactical bets’

How has your private equity portfolio performed?

We have had a good run the last couple of years, it’s exceeding our expectations over every metric and over every period. Our three-year performance is 17 percent and our one-year is 35 percent. A lot of that is just the fact we’re in a strong equity market in general and we’ve gotten some strong performance from a couple of funds, so it’s early yet I think for TMRS, but we’re definitely pleased with the performance so far.

How is your portfolio split?

We’re around 90 percent US, 10 percent international. By what we consider market exposure – NAV plus unfunded commitments – we’re 50-55 percent buyout, 20-25 percent growth and venture, but most of that is in growth equity, and then we’ve got another 20-25 percent in special situations, which is basically mezzanine and distressed.

We’re mostly small market and lower mid-market. We have some mid-market, we’ve got one or two large market, but we’re not trying to make a market capitalisation call. We’re trying to find less efficient segments, lower-priced and more sector specialists with stronger consistency of returns, and we’re finding that more often in the small market and lower mid-market.

Is the impending market correction affecting your investment decisions?

We’re looking at sector specialists – we try to be bottom-up in building this portfolio. If someone comes to market who’s the best at what they do and we can invest, we would invest there, we would not make a tactical sector call. But atthe margins, we’re trying to find exposure to managers that do things that are less cyclical and should have more stability in their top line, and we’re also thinking about how managers performed during the last downturn. We want to avoid really beta-heavy funds that maybe had a great fund before, a great fund after, and did terrible during the downturn. We would prefer someone who maybe over time doesn’t have the highest numbers but did well before, preserved during and has continued to do well after. We’re thinking about distressed because that is an area to deploy capital when the rest of the world blows up. But as far as tactical bets, we don’t make them, and we’re not changing our pacing model, we’re trying to be consistent. If we want to do $500 million and we find great managers who complement our portfolio, meet all our hurdles, we will put $500 million out. If we don’t, we will under-pace.

Will private equity continue to hold up when the market turns?

Because of how the asset class is priced, it will absolutely hold up better, at least initially, it just won’t get marked down as fast. I understand that is merely an accounting factor, but as far as its portfolio impact, the vast majority of public plans and endowments will actually get benefit from being there. Now, there are areas that I think might have bigger drawdowns than others, and there are areas where there will be opportunity to deploy capital, so we’re trying to figure out ‘what happens if’ rather than make predictions. I think the most overheated market segments are the ones that are going to be hit the hardest, that’s not a stretch to say.

Given the current strength of the fundraising market, are you seeing managers return to market earlier than expected?

We’re seeing several funds come back a lot sooner than we thought, and that impacts pacing. It also means your capital’s going to be put to work less quickly, which is an issue when you’re trying to get to target, so that does concern us, although we understand the reasons for it: investing is lumpy, and all of our funds go through a little dry spell and then at some point most funds will have three or four deals close in a very short period of time. If the general partner is saying, “We need to have capital available so we can continue our franchise because we’ve got two or three deals that are going to close,” it’s not my job to tell them they’re wrong.

What we want to see in that situation if we’re going to commit is that they don’t turn on the fees until the other fund is done. There are ways you can make that less of a conflict. If you’re only 45 percent in the ground and you still have two years left of your commitment window for the prior fund, you do not get to turn on fees on committed until the other one is done, period. That would be non-negotiable. But we would still commit if they would structure it appropriately.

For high-performing managers, is access an issue?

Access is an issue. In private equity I don’t think identifying good managers is tough, really, at all. Getting access to the best consistently and in scale to move the needle for a large portfolio, that’s more of a challenge.

For large public pensions, all of us have a ton of capital to put to work, we have people who source, we have consultants who work for us, we see a lot, so I don’t think any public pension team that’s got a $2 billion private equity portfolio will tell you it’s so hard to identify good managers. But the problem with putting out so much money is getting enough in the ground relative to your resources to monitor that portfolio.

We’re seeing a lot of spin-outs. Is there still space in the market for new managers?

I think there is still space. We also see some spin-outs from shops where there is not going to be a subsequent fund, so it’s not adding to the number of managers in the space. I think there will only be an increasing number of managers, and at some point there will be too many. My concern then isn’t necessarily the number of managers, it’s really the efficiency of the market – how many people chasing how many opportunities and how many dollars behind that.

The number of opportunities is going up because there are more and more private companies and fewer and fewer public companies, so you can have more managers. I think we’re still a long way from the private market being anywhere near as efficient as the public market, at least in some parts. You’ve got 15,000 mutual funds, you’ve got hundreds of thousands of traders and investors, you’ve got 10,000 hedge funds, and you’ve only got here in America 3,500 publicly traded companies, so that’s super-efficient. You’ve got 400,000 private companies that have EBITDA between zero and $50 million-$100 million, so that’s a deep pool. Is 10,000 too many? I don’t know, but I think for private equity, 2,000 in market year-to-date, there’s plenty of opportunities to go around.