Texas Teachers to expand principal investments

Teacher Retirement System of Texas officials plan an all-out campaign to make the $132 billion pension fund more attractive to the world's choicest — and biggest — principal investment opportunities.

In fact, T. Britton Harris IV, chief investment officer of the Austin-based pension fund, told trustees on Feb. 11 it is among his staff's top five 2015 priorities to make TRS the “preferred destination for attractive large investments.” The investment staff's label for separate accounts and co-investments is principal investments.

As big as it is, Texas Teachers has been outflanked in recent years by much bigger sovereign wealth funds when trying to participate in large investment deals with firms in private equity, real assets, energy and a variety of other strategies.

Mr. Harris and Eric Lang, senior managing director of external private markets, described to trustees a newly competitive global landscape for principal investments.

“There are only a few funds in the world that can do investments of $150 million or even $100 million. We can do transactions way above that size, but there's a lot of competition for deal flow,” Mr. Harris said in a webcast of the board meeting where he and Mr. Lang presented the concept.

Deal size is critical to generate the kind of returns Texas Teachers' executives are looking for “in this low-rate environment,” Mr. Harris said on the webcast. “There are a lot of small co-investments out there that aren't going to move the needle for us,” he added, noting that typically, investment opportunities are well below the $50 million mark.

In a post-meeting interview, Mr. Lang, who is heading up TRS' “preferred destination” initiative, explained the market for the size of principal investment deals his team is looking for — a “sweet spot” between $100 million and $250 million — has become global and very competitive, especially since the pace of deal flow has slowed since the beginning of the year.

TRS would not necessarily turn down a much larger deal, Mr. Lang said, noting that the fund's biggest principal investment to date — which he declined to identify — totaled $400 million.

The “staggering” outperformance of principal investments to date is the primary motivation behind TRS' goal to have “our partners think of us first” when they are putting together deals, Mr. Lang said during the interview.

Twenty principal investments totaling $2.2 billion, or about 15% of the fund's $15.4 billion private equity portfolio, for example, produced an annualized internal rate of return of 26.6% over the five years ended Sept. 30. That's 1,000-plus basis points more than the 16.5% IRR for the traditional investments in the portfolio, according to data Mr. Lang provided to trustees during the meeting.

As of the same date, 34 principal investments totaling $3.4 billion, or 22%, within TRS' $15.4 billion real assets portfolio returned an annualized five-year IRR of 17.4%, 560 basis points above the 11.8% return of traditionally structured investments in the category, Mr. Lang's data showed.

Since 2009, Texas Teachers' has committed almost $9 billion to more than 60 principal investments in the private equity, real assets, energy/natural resources and internal public markets portfolios, the fund's 2014 annual report said.

Principal investments are “an important way that we create alpha in the private market portfolio, and we want to move to create across the portfolio,” Mr. Lang said on the webcast.

During the interview with Pensions & Investments, Mr. Lang said TRS' alpha opportunities and special opportunities teams also will actively seek principal investment deals.

The alpha opportunities team is focused on long-only public or pre-public equity investments; the special opportunities group handles investments — including credit investments — that don't “fit into other portfolios,” Mr. Lang said during the telephone interview.

Last year, Texas Teachers' investment personnel fanned out across the globe on a fact-finding mission to get ideas from many of the pension fund's external money managers about better ways to compete for big principal investment deals.

“It was very enlightening to talk to our managers about what we're trying to do,” Mr. Lang said.

For one thing, TRS' managers predicted a highly attractive global principal investment deal flow totaling more than $8 billion, Mr. Harris related to trustees on the webcast. He did not specify the time frame for the rush of big deals.

For another, staff was surprised that between 80% and 90% of the 20 existing TRS managers with the most potential as principal investment partners said sovereign wealth funds were their “most important clients.”

Among the advantages sovereign wealth funds have over Texas Teachers is the vast amount of money, including cash flow, to invest without payout obligations, Mr. Lang said during the webcast.

Part of the reason for the quick rise in the competitiveness of sovereign funds for investment deal flow is their rapid growth: Aggregate sovereign wealth fund assets more than doubled to $7.1 trillion in 2014, up from $3.3 billion at the end of 2007, Mr. Lang said during the presentation.

Another big plus for sovereign fund investors is location, Mr. Harris said.

Many of the big non-U.S. managers “just go to the locals for principal investments. They aren't going to get on a plane and fly from London to the U.S., to Austin,” he said. “We have to convince these guys (money managers) that we are the one they need to bring their transactions to.”

“The key for us, what we want ... is to become a full underwriting partner, to get involved in deals from Day One,” Mr. Lang said during the meeting webcast.

TRS has a clear agenda for implementing its supercharged plan to attract more invitations from money managers to invest large sums in their principal investment opportunities. However, given the competitiveness of the global market for principal investments, Messrs. Harris and Lang deliberately provided scant details.

Trustees were able to view the full slide presentation in their “transparency” board documents, but 50% of the slides shown during the public meeting were termed “confidential” by the presenters and as “page intentionally left blank” in the online version of meeting documents.

Still, a few hints were given.

For example, one way TRS could conquer the location problem would be to open offices in financial capitals in Europe and Asia in order to be closer to the deal flow from non-U.S. money managers, Mr. Harris said during the webcast.

Mr. Lang told trustees that investment staffers will work to develop “maximum collaboration with general partners” to get a look at their top 25 deals each year.