HARRISBURG, Pa. - A disco singer once sang to male suitors: No romance without finance. Trustees of Pennsylvania's largest pension fund are essentially saying the same thing to private equity general partners.
The board of trustees of the $33 billion Pennsylvania Public School Employes' Retirement System now requires general partners to invest 5% of the equity in partnerships if they want the pension fund to invest.
So far, two current money-making partnerships won't get additional commitments from Pennsylvania Public School when the partnerships begin raising money for new funds.
But four other funds to which the pension fund recently committed, said they would commit to at least 5% of the total capital raised.
Most partnership documents require the general partners to invest at least 1% of the fund total, and few pension funds will commit to a partnership that doesn't have at least the minimum. More is often required.
But with the policy adopted late last year, Pennsylvania Public Schools is believed to be the first with a minimum requirement.
Fred Tecce, chairman of the pension fund's finance committee, was the impetus behind the adoption of the policy.
"It is a philosophy that says we are not going to do business with people who don't have an aligned interest with us," said Mr. Tecce. "We've decided that we want partners with strong backgrounds, knowledge and their own money at risk.
"In the venture capital field when you put up 1% and get 2% (annual management fee) what do you care if it goes broke or not?" said Mr. Tecce.
"I am not impressed when a general partner says, 'If we don't perform, you won't reinvest with us.'*" he added.
Pennsylvania Public Schools' policy applies to all styles of private equity and includes real estate, said John Lane, chief investment officer with the fund.
The Pennsylvania Public Schools' is not standing alone on its policy. The $10 billion pension fund for American Airlines, while lacking a formal policy, is a kindred spirit.
"We clearly look for general partners to make a significant commitment somewhere in that range," said William F. Quinn, president of AMR Investments, which manages the pension fund of the Fort Worth, Texas, airline.
"I wouldn't say we are iron clad, that if they made a commitment of between 3.5% and 4% we wouldn't invest," said Mr. Quinn. "We clearly will not invest if the level is 1%.
"We have come up with a rule of thumb of a partnership commitment equal to three years of management fees as a starting point," said Mr. Quinn. "Sometimes it's in the (partnership) documents, sometimes it is in a letter."
Private equity observers note Pennsylvania Public School's policy is exclusionary to younger partners who have not yet made enough money to invest 5%; that the fund is excluding itself from potentially good deals; and it disproportionally effects venture capital partnerships, which don't generate the fees of a buy-out or real estate partnership.
"If you raise a $500 million fund and you have to pay up $25 million, that is a lot of money," said a private equity placement agent, who spoke on the condition of anonymity. The general partners might be wealthy, but a lot of that wealth might be tied up, the agent noted.
But Mr. Tecce is unmoved.
"I don't worry about missing an opportunity," said Mr. Tecce. "I worry about losing the Teachers' pensions.
"I would rather be safe than sorry," he said. "There will be plenty of opportunities."
Mr. Tecce said his fund has done deals with venture capital partnerships in which the general partners have invested 5%. He noted venture funds get a 20% carried interest and the general partners are multimillionaires.
"I don't feel the need to give them a break," he said. "They have the money.
"They will tell you the young partners coming along don't have the money. They are not my problem.
"If there are others who can perform equally as well, I have an obligation to go with those willing to take the risk with me," Mr. Tecce said.
"My responsibility is to the pension fund."
Pennsylvania Public School does have a development fund for small money managers that don't meet the pension fund's criteria, and Mr. Tecce suggested that might be a place to start for those partnerships that can't make the 5% minimum.
The policy became effective at the beginning of this year, and two of the existing partnerships will not have the pension fund it as an investor in new funds because the general partners declined to commit the 5%.
Westbrook Partners, a New York real estate investor, and venture capitalist Patricof & Co. Ventures Inc. said they would not invest the 5% minimums to new partnerships, according to Mr. Lane.
Attempts to reach Westbrook were unsuccessful. Patricof officials declined to comment.
Both partnerships have performed well for the pension fund, but Mr. Tecce isn't concerned that a good relationship will end because of the policy.
Mr. Lane noted his pension fund has committed to four partnerships since the policy became effective.
Trustees committed $30 million to Goldman Sachs Mezzanine Partners L.P.; $200 million to Lehman Brothers Merchant Banking Fund II L.P.; $50 million to TL Ventures II L.P. and $75 million to TPG Partners II L.P.
Mr. Tecce said he took his cue on the investment minimum from the general partners of the large investment banking firms that invested significant sums of money in partnerships they raised.
"I am not the guy that started this," said Mr. Tecce. "The people who created this are the big investment banking firms."
But he might be the one responsible for it becoming a policy.
"I haven't heard of any formalization of that in the public sense," said William Farrell, managing director with Farrell Marsh & Co., a Greenwich, Conn.
"Pennsylvania has formalized this as a criteria, but other investors follow it less informally in the screening of partnerships," said Mr. Farrell.
"There are other investors in the market who will look very favorably on the co-investment as they screen new offerings," Mr. Farrell added.
