It’s been a good year for some of the big US pension systems: a number have already reported returns from their private equity portfolio significantly higher than last year’s single-digit figures.
Two of the big winners have been California Public Employees’ Retirement System and California State Teachers’ Retirement System. The Sacramento duo posted very similar private equity returns – 13.6 percent for CalPERS and 13.9 percent for CalSTRS. Last year, the two returned 5.4 percent and 5.9 percent respectively.
The Florida State Investment Board, which includes the state’s retirement system, posted a 10.65 percent return for its private equity portfolio, having returned 7.22 percent for the 2012 fiscal year.
These three results are more or less in line with the median return for pensions with more than $1 billion in assets, which according to The Wilshire Trust Universe Comparison Service was 12.4 percent. In 2012, the median private equity portfolio return was 5.17 percent.
The Alaska Permanent Fund, one of the largest US sovereign wealth funds, fared even better: its private equity portfolio returned 15.3 percent during the fiscal year, having returned 9.8 percent last fiscal year.
Although all of these LPs substantially increased their portfolio returns year-on-year, each one still missed its short-term benchmark. Alaska was shy by about 5 percent, while the California pensions were between 2 percent and 4 percent short and Florida missed out by 1 percent. CalSTRS’ benchmark is based on the Russell 3000 index, excluding tobacco and plus 300 basis points, while CalPERS’ benchmark is custom.
“When the public markets shoot up like a rocket like they did last year, our asset class isn’t going to keep up in the short-term,” said Margot Wirth, CalSTRS’ director of private equity. CalSTRS’ 10-year benchmark is 12 percent, which is right in line with its returns, Wirth points out.
The missed benchmarks aren’t entirely surprising, because it doesn’t make sense to compare returns on an annual basis, according to Kelly DePonte, a partner at Probitas Partners; a five-year horizon is more appropriate, he suggests.
So why the sudden jump from single-digit to double-digit returns in one fiscal year?
Favourable macro tailwinds, including the greater availability of low-cost debt, have clearly helped private equity managers boost their returns, Jay Rose, a partner at StepStone, tells Private Equity International.
“A significant amount of liquidity has been generated across the various strategies within the asset class, most notably leveraged buyouts which are the core holdings of most institutional investors’ private equity portfolios,” he explains.
This improvement in the debt market followed a volatile 2011, says Christian Kallen, vice president of Hamilton Lane’s fund investment team. “There is a very robust debt market, which was open for the whole year,” Kallen says. “This really helped private equity firms refinance their companies and helped on the M&A side as well.”
When the public markets shoot up like a rocket like they did last year, our asset class isn’t going to keep up in the short-term.
Margot Wirth, CalSTRS’ director of private equity
Rose adds that a “flurry” of underlying portfolio companies were sold in the latter part of 2012 – having been stuck on the books for longer than expected. “You also had a fairly significant increase in holding periods over the last investment cycle … If you go back and think about what was dubbed as the ‘golden era’ of private equity, a lot of firms held companies longer than they wanted to.”
As such, the size and maturity of these institutions’ private equity portfolios is also significant. For example, CalPERS allocates 12.4 percent of its $255 billion assets to private equity, while Florida allocates nearly 5 percent of its $133.9 billion fund to the asset class.
“The four institutions are all people who have been in the market for a while so they have mature portfolios,” says DePonte.
The recovery in the public markets has also helped valuations, says Kallen. “At the end of 2011, you saw a lot of volatility in the debt market and in the public market, combined with the issues in Europe. [But markets] have generally done well in the past year.”
Given that recovery, “the returns seem to be [in line with] what I would expect for public pension plans”, DePonte says. “I would have been shocked if they hadn’t gone up this high.”
This past fiscal year looks to have been a strong one for public institutions’ private equity portfolios, based on those funds that have released their numbers (and on the Wilshire Trust median). As more pensions release returns, that should become ever clearer – which is good news for institutions struggling to find the sort of yield elsewhere that they need to meet their long-term obligations.