More institutions using managers as strategic partners

Updated with correction

The tide of large pension funds creating strategic alliances with alternatives managers is swelling.

The alliances “are naturally attractive to large institutional investors,” said Mike Moy, a managing director at Pension Consulting Alliance Inc. in Mission Viejo, Calif., citing lower fees and broader investment strategies.

Among the funds that are planning, have created or have increased such relationships recently:

c the $153.7 billion California State Teachers' Retirement System, West Sacramento, whose investment committee is poised to approve a recommendation at its meeting Aug. 2 that would allow the pension fund to enter into customized funds with alternatives managers;

c the $24 billion Texas Permanent School Fund, Austin, in April selected Grosvenor Capital Management LP and Blackstone Alternative Asset Management as strategic relationship managers who, together with internal staff, will co-manage portfolios of direct investments in hedge funds;

c the $72.1 billion New Jersey Division of Investment, Trenton, in December began a $1.5 billion strategic relationship with The Blackstone Group LP;

c the $224.1 billion California Public Employees' Retirement System, Sacramento, in November approved a $500 million strategic partnership with Blackstone; and

c the $109 billion Teacher Retirement System of Texas, Austin, also in November committed $3 billion each to Apollo Global Management LLC and Kohlberg Kravis Robert & Co. LP.

Mr. Moy said the partnerships can react quickly to investment opportunities across asset classes. Plus, pension funds potentially could reduce the number of alternatives managers in their stables, saving fees and manpower monitoring the investments.

“It's a more efficient vehicle,” he said.

For example, officials at Blackstone Group have created a custom fund for New Jersey — the tactical opportunities fund — that will invest across hedge funds, private equity, real estate and commodities in search of time-sensitive or opportunistic investments.

It is the first time Blackstone offered a fund cutting across asset classes, according to David Blitzer, a New York-based senior managing director with the private equity firm.

New Jersey will invest up to $750 million in the tactical opportunities fund and another $750 million in a custom credit fund that will look for opportunistic long and short investments in the below-investment-grade corporate credit markets as well as a variety of credit opportunities involving energy production and distribution, said Timothy Walsh, director of the New Jersey Division of Investment.

He said New Jersey officials approached Blackstone about custom accounts because of the firm's ability to source unique investment opportunities around the world.

“We're trying to buy assets a lot of private equity firms won't touch because they're not, you know, 20% yielders,” Mr. Walsh said.

He said New Jersey would be happy with a 10% to 12% rate of return from assets the funds will be buying, which could range from distressed debt to pipelines.

Mr. Blitzer said Blackstone plans to top New Jersey's expectations, and return 15% to 20%.

CalPERS also made a $500 million commitment to a tactical opportunities fund with Blackstone in May. Mr. Blitzer said Blackstone staff will invest in the same areas for both the New Jersey and the CalPERS accounts. He said the pension plans will own a pro-rata share of the assets, depending on the amount of their investment.

Mr. Blitzer said a key concept of the separate accounts will be that Blackstone's global teams in different asset classes will sit on the same investment committee and will coordinate with each other on the best opportunities.

The biggest recent allocation to strategic partnerships in terms of dollars is the $6 billion total committed by Texas Teachers to Apollo Global Management and KKR.

Texas Teachers' officials would not discuss the allocation. Spokesman Howard Goldman provided a news release from November stating the partnership would result in improved diversification and potentially reduced long-term investment risk.

At CalSTRS, if the board gives the go-ahead, the customized funds would allow the pension fund to obtain lower fees and have more input into investment decisions than in traditional private equity funds, Margot J. Wirth, director of private equity, said in an interview.

“It's one more tool in our toolbox,” she said. “Separately managed accounts are part of the landscape, and we want to participate.”

Fees reductions are a big draw for executives at pension plans involved in strategic partnerships. New Jersey's partnership with Blackstone involves no commitment fee until money is deployed, Mr. Walsh said.

“Here's one of my pet peeves,” Mr. Walsh said. “You go into traditional funds and in many cases you are paying 2% on commitment (committed capital) or 1% on commitment and they may not invest the money for two to three years or sometimes even more than that. It's expensive to be an investor because you are paying money that is not working.”

Mr. Walsh said New Jersey also negotiated a 1% management fee, with Blackstone taking a 15% cut of any profits. Traditional alternatives funds charge as much as 2% and 20%, with the management fee applying to the total fund.

At a CalPERS investment committee meeting on June 11, Chief Investment Officer Joseph Dear briefly discussed the fund's partnership with Blackstone, saying the pension fund had negotiated reduced fees from the company. (Requests for proposals put out by CalPERS in September show the pension fund could eventually invest up to $2 billion with strategic asset managers.)

Mr. Dear was unavailable for further comment.

Officials of the $24.5 billion South Carolina Retirement Systems, Columbia, also were motivated by fee savings when South Carolina became one of the first public pension systems — in 2008 — to enter into strategic partnerships with alternatives managers. But generous agreements entered before the full impact of the financial crisis hit have turned out to be costly, said State Treasurer Curtis Loftis Jr.

Fees to 12 strategic partners that managed $5.8 billion in the fiscal year ended June 30, 2011, totaled more than $150 million, according to records provided by Mr. Loftis.

For that same year, the strategic partners, returned 11.3%; South Carolina's total portfolio returned 18.59%.

Mr. Loftis, a trustee of the retirement system's investment commission, said the commission didn't have the structure in place to properly monitor the partnerships. “Strategic partnerships can be an effective tool, but they must be properly managed,” Mr. Loftis said.

“The downside of strategic partnerships is the massive size (of the commitments) so while gains can be outsized, so can losses. Many states are moving into this style of partnership, and I hope they learn from the "early birds' that a properly run back and middle office is a key to success.”

Mr. Loftis said he expects to soon hire an outside firm to conduct a review of the fees paid to strategic partners.

Yariv Itah, a partner with money manager consulting firm Casey, Quirk & Associates LLC Darien, Conn., said he expects strategic partnerships will continue because they make up the intersection of several key trends: the demand from institutional investors for investment solutions; increased outsourcing; and increased demand for alternatives.

Mr. Itah said only a handful of large money managers, however, will have the deep capacity to create broad investment solutions for pension plans and other institutional investors.

“Breadth of investment capabilities is one critical factor,” he said “And the other critical factor is the ability to package a solution from all these different vertical investment capabilities.” n