Milken discussions range from direct investment to sports teams

Institutional investors at the Milken Institute Global Conference in Beverly Hills, Calif., were investigating new ways of investing that would provide risk-adjusted returns.

Everything from investing directly in all types of alternative asset classes — such as private equity, natural resources and real estate — to investing in sports teams was discussed late last month.

Also, investors on a panel titled, “The view from institutional investors: Where will returns come from” said one of the things that keeps them up at night is their fixed-income portfolio.

The five pension funds in the $150 billion New York City Retirement Systems have a $45 billion fixed-income portfolio, half invested in core, said Seema Hingorani, chief investment officer for the systems' Bureau of Asset Management. Plan officials are looking to diversify the portfolio by expanding into alternative fixed income and European debt. Officials also are interested in investing in real estate debt as well as lending and student loans, Ms. Hingorani said.

Jerry Albright, deputy CIO for the $126 billion Teacher Retirement System of Texas, Austin, said stable value is a concern and the pension fund is interested in boosting its exposure to energy. “It's … in our backyard,” Mr. Albright said.

Several of the panelists are in the midst of making big changes to their total portfolios.

Michael Sabia, president and CEO of the C$250 billion (US$227 billion) Caisse de Depot et Placement du Quebec, Montreal, said that 85% to 90% of the portfolio is invested internally.

Officials at Caisse — the manager for provincial, municipal and other pension funds in Quebec as well as other provincial entities — made substantial changes recently to their public equities portfolio, focusing C$50 billion on a pure absolute-return strategy, without regard to index.

“If the (public equity) team wants to invest in a stock, it will buy the stock regardless if it is in an index,” Mr. Sabia said. “And we are prepared to take large, concentrated positions.”

In alternative investment areas, Caisse continues to make direct investments in private equity, including investing alongside other institutional investors at home such as the C$201.5 billion Canada Pension Plan, Ottawa, and around the world, Mr. Sabia said. To that end, the pension fund is building a research team with operational expertise.

Instead of focusing on how a deal is structured, officials are hiring “people who understand the operations of those businesses,” Mr. Sabia said. “Operations are a source of value over financial engineering.”

In addition, Caisse de Depot officials are working with select private equity firms to get access to deals the firms see but are not interested in because the investments do not fit their return requirements or private equity fund time horizon, Mr. Sabia said.

Li Keping, vice chairman, president and CIO of the $600 billion China Investment Corp., Beijing, said half of the sovereign wealth fund's $200 billion international portfolio is allocated to “long-term assets,” including private equity, real estate, infrastructure, agriculture and private deals in private companies. The rest is allocated to public investments ,including equities, fixed income and absolute return.

Between 60% and 70% of the international portfolio is externally managed. The CIC is looking to co-invest with managers that can lend expertise to transactions that CIC staff lacks, Mr. Li said.

New York City's Ms. Hingorani said the New York City pension funds would like to invest more like the Canadian pension plans that invest directly, but they are not there yet.

New York City's target allocation to alternative investments will grow to 25% by 2016 up from about 11% now.

New York City pension fund officials also are looking to increase co-investments and direct investments in their private equity portfolio, and they are investing more in separate accounts, and joint ventures as well as making direct investments in real estate.

Indeed, investing directly was a big topic at this panel, moderated by Christopher Ailman, CIO of the West Sacramento-based $183.3 billion California State Teachers' Retirement System.

Jane Mendillo, president and CEO of Cambridge, Mass.-based Harvard Management Co., which oversees the investment management of Harvard University's $32.3 billion endowment, said Harvard Management already makes direct investments in natural resources and has funded the planting of a million trees in countries all over the word.

She said Harvard Management also directly invests in real estate, but has no direct investments in private equity. Ms. Mendillo said it is difficult to build an internal team of the best talent to compete.

New York City's Ms. Hingorani said bureau officials would like to directly invest in real estate, but gave no timetable for doing so.

In an interview, Mr. Ailman said it is difficult for public pension funds to invest directly because they do not have the resources — including the capital to hire — and retain investment executives at market rates.

At least one public pension plan investor, Gordon Fyfe, president and CEO of the C$95 billion (US$86 billion) Public Sector Pension Investment Board, Montreal, said the board invests directly because officials have found private equity returns wanting, especially relative to its high fees. Mr. Fyfe made his comments while speaking on a panel, “The alternative reality of alternative investments,” which was moderated by Andrew Whittaker, vice chairman of investment banking firm, Jefferies LLC and vice chairman of Jefferies parent company, holding company Leucadia National Corp.

Indeed, Mr. Fyfe said asset owners might be better off making leveraged public equity investments than investing in private equity.

In comparing private equity returns as reported by Cambridge Associates' U.S. Private Equity index returns to returns of the S&P 500 stock index with 50% leverage, PSP officials found private equity underperformed the leveraged S&P 500 in most time periods, Mr. Fyfe said.

“There are some great managers, great (general partners) that exist, and we have both in our portfolio,” Mr. Fyfe said.

The pension plan's C$26 billion private asset portfolio includes C$4 billion in hedge funds, he said. Some 75% of the hedge fund portfolio is managed internally.

The challenge for investors is to find great managers in private equity, he said. “They all tell you they are ... top quartile,” Mr. Fyfe said. But the private equity fee structure doesn't distinguish between good and bad managers, he said.

Another investor challenge is to make sure private equity managers' interests are aligned with the investors' interests. “This means putting real cash alongside your cash and not deferred fees” in lieu of cash, Mr. Fyfe said.

The Canadian model — in which pension plans invest directly in private equity — eliminates the high fees that cut into returns, he said. One strategy that PSP is employing is to fund new private equity firms that are started by private equity executives from existing firms, Mr. Fyfe said.

“We do large co-investments where there are no fees, no carry,” he said. “We are willing to put $500 million in a fund and have $500 million on the side to do a co-investment with them.”

Fellow panel member Kneeland Youngblood, Dallas-based founding partner of middle-market buyout firm Pharos Capital Group, countered he could not see the Canadian model being exported to the U.S.. The reason: the inability of public pension plans to attract the “best and the brightest” due to a failure to match private-sector pay.

Conference panelists even weighed in on whether they would buy the Los Angeles Clippers basketball team after being told of the National Basketball Association's lifetime ban of Clippers' owner Donald Sterling.

“This is the fourth time this has come up in 36 hours,” quipped Jonathan Nelson, founder and CEO of private equity firm Providence Equity Partners, Providence, R.I.

In response to a question, Mr. Nelson said he hoped Mr. Sterling would sell the team. Mr. Sterling, who was also fined $2.5 million by the NBA on April 29, purportedly uttered racist comments in a recording made public.

That said, most of the panelists agreed with panelist John Danhakl, managing partner at private equity firm Leonard Green & Partners, Los Angeles, that a sports team is not appropriate as an investment for a private equity fund, which has a fixed life.

Instead, the pattern of ownership of sports teams is that they are owned by wealthy individuals, said David Bonderman, founding partner of alternative investment firm TPG Capital, San Francisco.

Leon Black, chairman and CEO of alternative investment firm Apollo Global Management, New York, disagreed. He said that things have changed, noting that the purchase of the Los Angeles Dodgers baseball team by a consortium led by investment firm Guggenheim Partners was based on the cash flow from network television contracts.