New look for Texas Teachers' private equity, real assets

Texas Teacher Retirement System is redesigning its combined $20.2 billion in private equity and real assets, radically changing the fund's relationships with its investment managers.

The $109.1 billion Austin-based system will eventually trim its 115 manager relationships in those classes, making larger commitments with a smaller number of managers. The number of remaining relationships has not been determined, according to an e-mail from Juliana Helton, fund spokeswoman.

In all, the system has $14.3 billion targeted but not yet invested — $7.1 billion in private equity and $7.2 billion in real assets. This year alone, system officials plan to commit $3.2 billion in real assets and $1.5 billion in private equity.

Its real assets category includes real estate, real estate investment trusts, publicly traded real estate debt and inflation-protection securities.

As part of a broader change, Texas Teachers plans to commit an additional $700 million to invest in private equity and real asset emerging managers over the next two years.

The program is aimed at boosting returns and giving the fund “a competitive advantage via more committed capital within a customized vehicle,” according to materials given to the pension fund's board.

“They are taking a page from the foundation (and endowment) playbook by investing in emerging managers and more money in fewer managers,” said an executive at a money management firm that specializes in endowments.

There's been much discussion among private markets investors about trimming the number of managers and taking steps to get more control over these locked-up investments. A few investors — such as the $225.6 billion California Public Employees' Retirement System and the $27.6 billion Harvard University and $16.7 billion Yale University endowments — have adopted similar strategies.

Texas Teachers, however, appears to be putting its own stamp on the program. Officials are forming a strategic partnership network that will include two to four managers with average fund commitments of between $250 million and $500 million. Together, those strategic partnerships will account for as much as 35% of the system's private markets portfolio, which includes both private equity and real assets.

These partnerships will create customized investment vehicles that include other institutional investors. And, according to the board materials, Texas Teachers officials expect their fund to be, long term, the best-performing client in the strategic partnership networks.

System officials also intend to co-invest on three to four “unique/dislocated investment opportunities investments” with the strategic partners, the board materials state.

The largest portion of Texas Teachers' private markets portfolio (45%) will be invested with 40 to 60 existing managers that system officials consider “key relationships.” The ceiling on commitments to these managers will be smaller than the ceiling for strategic partners: $300 million vs. $500 million.

Currently, the system's 10 largest private equity relationships are with Apollo Global Management, Blackstone Group, CVC Capital Partners, Credit Suisse, Carlyle Group, Apax Partners, TPG Capital, First Reserve Corp., Lion Capital and Kohlberg Kravis Roberts & Co. The managers handle a combined 49% of Texas Teachers' $9.8 billion private equity portfolio.

The top 10 real asset managers are Principal, Blackstone Group, Prudential, Stockbridge, J.P. Morgan Asset Management, LaSalle Investment Management, USAA Real Estate, Colony Capital, Forum Securities and Stratford Advisory Group Inc.

The other 20% of the private markets portfolio will be in “differentiated” or opportunistic strategies with 40 to 60 new relationships.

At the same time, the system is adding a new real asset special situations suballocation, which includes publicly traded debt and equity investments. The target suballocation is 15% of the $10.4 billion real asset portfolio. Some $575 million in existing investments will be added to this portfolio.

System officials expect that this new “valuation-based” strategy will result in faster execution, better information and a better alignment of interest between TRS and its private equity and real assets managers.

But there are limits to the strategy. Making larger investments with fewer managers makes selection even more important. Top performers could have a few good years followed by several bad ones.

Private equity and real estate consultants contacted by Pensions & Investments for this story either declined to be interviewed or declined to speak on the record.

“Emerging managers are willing to go into different geographies and sectors, and you can occasionally achieve superior risk-adjusted returns,” the endowment manager said.

Proponents of the idea contend emerging managers are young and hungry and can outperform their peers. Currently, most institutions that invest in emerging managers do so through their private equity program, noted a consultant who declined to be identified.

Texas Teachers' general consultant, Hewitt EnnisKnupp, will oversee the new emerging manager direct investment program, which is slated to invest a total of $350 million in both 2011 and 2012, according to documents prepared for the fund's June 16-17 board meeting.