The case for 'in-state' private equity investing

A recent resurgence of private equity stories in the press is casting new light on the various strategies and potential benefits of private equity investing. One such strategy, “in-state” private equity investing, which involves geographically focused and returns-oriented investments, falls under the more widely known category of economically targeted investment programs.

ETI programs, also known as dual-purpose or impact investing, have prevailed for decades and throughout many economic cycles. Managed properly and with the appropriate resources, in-state programs — typically private or public assets applied to targeted investing at a state or regional level — are a proven model for states and pension funds seeking competitive, risk-adjusted returns. In an era of sluggish economic growth, 30-year high unemployment and uncertain investment returns, in-state private equity ETIs can contribute to the macroeconomic solution and achieve sought-after returns.

In-state programs can be viewed as highly complementary within the context of a pension fund's larger allocation mix. Contrasted with traditional state economic development funds, which emphasize social benefits as the primary goal, returns-focused in-state programs are desirable vehicles for pension plans because their very design places risk-adjusted alpha ahead of so-called collateral benefits. The collateral benefits include general business development, job creation or retention, tax revenue generation, affordable housing construction or other growth. In our experience, the impact can still be achieved without sacrificing returns.

In each program that we have managed, investors have chosen to pursue different strategies to measure and monitor overall performance. These can range from hiring third-party consultants to assess the economic impact of the investment, to tracking specific metrics and job growth independently. The more significant the program in size and focus, the more is required to ensure objectives are met. Data that have proven useful include measuring the total number of jobs affected or created from an in-state program, the percentage of total employment growth vs. the local area, and the number of workers and companies in low to moderate income zones.

The impetus for developing in-state programs varies, but typically starts with state leadership initiating positive economic change by increasing capital availability through a third-party fiduciary. Motives include a desire to generate manufacturing or technology growth and concerns over falling employment. A number of states see a particular opportunity to attract equity capital to promote technologies developed in leading universities or to foster the next stage of growth for successful small businesses that do not have a local lending environment to which to turn.

Third-party accountability, combined with bottom-up research, proper due diligence, analytical rigor and appropriate alignment of incentives among all investors are key ingredients for success. Employing an experienced investment manager — one with the platform and resources capable of building long-term relationships that help cultivate local centers of excellence in targeted economic communities — is also critical.

Encouraged by the success of existing programs, a number of additional states are evaluating in-state private equity possibilities available to them. In many cases, state leadership views these targeted investment strategies as the most attractive private equity option for their state pension resources.

Throughout the U.S., and increasingly worldwide, states and regions present opportunities to successfully implement local-impact investment strategies that both generate attractive returns and contribute to economic growth. Achieving this winning combination requires the key ingredients of a properly aligned structure, a returns-oriented approach and an experienced investment manager.

David Helgerson is a principal with private equity manager Hamilton Lane in Bala Cynwyd, Pa.