South Dakota Investment Council is, by its own admission, unlike any other US public pension. At a time when many institutional investors are piling capital into private equity, the Sioux Falls-based fund is doing the opposite.

SDIC manages $14.8 billion in assets across six funds, including the $12.2 billion South Dakota Retirement System and the $1.2 billion South Dakota Cash Flow Fund.

The pension has as much as 9 percent exposure to private equity and is slowing its deployment to the asset class and other equity-like assets as part of its “contrarian” investment strategy, state investment officer Matt Clark tells Private Equity International.

“It was around 7 percent a decade or so ago and then it went up after the crisis because there were a lot of opportunities,” he says. “And that’s been slowly working its way back down.”

Silver Lake, Blackstone and Cinven accounted for the largest pools of assets within SDRS’s $782 million private equity portfolio as of June 2017, according to its latest annual report. The portfolio also includes commitments to KKR, Carlyle Group and CVC Capital Partners, each of which has raised a mega-fund  over the past two years.

“The wall of commitments out there is competition for underlying deals, and the more money in private equity chasing a given number of deals, the more bid up the prices get and the less the return prospects are,” Clark says.

“When those conditions suggest poor prospects for a time, well then we pull back. If we’re right then there’ll be disappointment experienced by those involved, and then opportunities will re-emerge and we’ll be back.”

Risky business

Clark’s bearishness is not based on gut instinct; the loss of appetite comes from a formula SDIC uses to assess investments. It gauges the fair value of potential assets by estimating future cashflows of these investments and comparing that to the price.

In a neutral risk environment around 70 percent of SDIC’s portfolio would be held in what it considers to be risky assets, such as stocks, private equity or real estate, with the remainder in bonds, Clark says. If prices are well above its appraised fair value measures then it cuts risk to around 50 percent, with the remainder going into either investment-grade bonds or cash.

Though the strategy provides some protection from market headwinds, it can also mute short-term performance. SDRS – the largest of SDIC’s funds – had an estimated 1.1 percent net return for the fiscal year-to-date as of 31 July.

The long-term rewards, however, are clear: South Dakota had the third-lowest pension liabilities shortfall of any US state as of December, behind only Vermont and North Dakota, according to research from the American Legislative Exchange Council.

“Right now as minimum risk exposure in the markets keeps going up we’ll be suffering on a relative performance basis, and that pain will discourage imitators especially when they haven’t tasted the rewards in the past,” Clark notes.

“It’s kind of a chicken and the egg thing on that. It’s hard to start off being a contrarian if you think you’re going to get fired after the first wrong call, therefore you never take that first bold step and you never build up a track record.”

Bursting the bubble

South Dakota is unlikely to remain a bit-part player in private equity forever.

“The Federal Reserve and other monetary authorities around the world are creating these bubbles to push things to bigger extremes on the overvalued side than we’ve historically seen,” Clark adds. “That then leads to some kind of bubble that ultimately gets pricked and creates a crisis where it overshoots on the other side, [which] just creates huge opportunities.”

And while the heady fundraising environment has left some LPs struggling to secure their desired commitment size, or in some cases even a place in the vehicle, Clark is not concerned about losing out in future as a result of neglecting important GP relationships.

“I would think that partners of ours would appreciate the fact that we show up when they need us most, which is when things are bad and others are making excuses and they’re struggling to have much of a fund,” he says.