Institutional investors regain power

Tough fundraising times give plans upper hand with fees and terms

Institutional investors are back in the driver's seat after years of yielding power to private equity firms.

As fundraising gets tougher for investment managers, pension funds, endowments and foundations find themselves in a position of power — and some are using that clout to get better deals on fees and terms from their investment managers.

“We'll be in a better position to negotiate in the current market than 12 to 24 months ago,” said Jay Fewel, senior investment officer for the Oregon Investment Council's $10 billion private equity portfolio. The Oregon Investment Council, Salem, manages the $54.3 billion Oregon Public Employees Retirement Fund, which is based in Tigard.

Like other institutional investors, Oregon has not made a private commitment recently. A number of investors are over-allocated to private equity and cutting back future commitments. The council made all its 2008 commitments to private equity funds earlier this year and is looking at paring back its private equity commitments for 2009. However, that's a work in progress that depends on a number of factors including the economy and whether there are large write-downs by fund managers, in part due to accounting changes requiring them to use fair-value reporting, Mr. Fewel said.

With stock and bond markets dropping sharply, investors have found themselves overallocated to private equity and real estate. At the same time — and for the same reason — funds themselves are now taking longer to close and managers can no longer give investors take-it-or-leave-it ultimatums.

“Limited partners have more power now,” said Brian Schneider, managing director, real estate and natural resources, at the University of Pennsylvania Investment Office, Philadelphia, in an interview at the Pension Real Estate Association Fall Conference in Chicago last month. The office manages the university's $6 billion endowment.

For his part, Mr. Schneider has not had to delay or cease paying capital calls because the university adopted its 10% real estate allocation two years ago, which officials are building up slowly, and so they still have cash to pay capital calls on time.

“We just built the program from scratch two years ago,” Mr. Schneider explained during a panel discussion at the conference. “We have little payouts and we have cash.”

But for most big institutional investors, their overallocation to some alternative asset classes, combined with a lower amount of profit distributions from private equity and real estate mangers, has left them short of cash to pay capital calls for the funds to which they have already made commitments.

Much lower distributions

“Under normal circumstances, we receive regular distributions from private funds and expect these distributions to exceed capital calls,” according to the recently released third-quarter report by the University of Virginia Investment Management Co., Charlottesville, which manages the university's $4 billion endowment.

However, the report noted that in recent quarters the endowment has received much lower distributions from its “private fund” managers — defined as private equity, real estate and natural resources.

“In conversations with our private managers over the past two weeks,” the report noted, “they tell us that the financial crisis precludes sales of existing investments and we should not expect any distributions this quarter and few in 2009.”

Like other pension funds, endowments and foundations across the country, UVIM is selling off its liquid, stock and bond assets as well as redeeming hedge funds to meet capital calls from real estate and resource managers. Through 2010, UVIM expects $100 million in distributions from private funds in 2009. It expects to liquidate roughly $400 million from public equities to fund capital calls from private equity funds, and plans to redeem about $400 million from hedge funds to meet capital calls from from real estate and resource managers.

“University and UVIMCO leadership take the matter of liquidity seriously, and we don't anticipate any liquidity problems,” said Leonard W. Sandridge, UVIM executive vice president and chief operating officer, in an e-mail response to questions. “We are and will continue to be able to meet all calls by our private equity managers on an ongoing basis.” Some investors are not paying or are holding off capital calls for underperforming managers as they did after the tech bubble burst. Not wanting to throw good money after bad, they stop investing with some venture capital firms.

Other pension funds are also selling some assets, starting with fixed-income securities, to meet capital calls, according to three pension fund executives who declined to be identified. With distributions down for the foreseeable future, many are demanding and getting extensions, they said. Since they are not getting distributions, they are selling liquid investments to meet capital calls. But they are also telling their real estate and private equity fund managers to delay capital calls.

Officials at the California Public Employees’ Retirement System, Sacramento, are making capital calls but are working with investment managers on timing, said Clark McKinley, spokesman for the $197.6 billion system, in an interview. Still, he declined to say whether fund officials had delayed payment of capital calls.

“Our relationships typically involve some fine-tuning of the timing of capital calls. We often shift cash around among asset classes, so it's not unusual to "sell stocks' to generate cash to be used for other asset classes,” Mr. McKinley said in a follow-up e-mail.

Eventually, capital calls will slow down because investment managers are buying few new companies or properties for their portfolios unless they get a real bargain, according to Melissa Ma, co-founder of San Francisco-and Hong Kong-based private equity fund of funds firm Asia Alternatives. (The firm just closed its $950 million Asia Alternatives Capital Partners II LP on Nov. 3.)

The pace of capital calls have already slowed, noted Oregon Investment Council's Mr. Fewel. “Most of the capital calls we see are for management fees.”

Contact Arleen Jacobius at