Asset owners, managers trying new ways to take direct approach

Some asset owners and money managers are starting to tinker with the traditionally high-fee alternative investment model.

Asset owners have been talking about investing directly for years, but many lacked the funding to pay market prices to bring alternative investments in-house. Attempts to form consortiums also have stumbled. Now, investors and managers are taking a different approach, focusing on their advantages aside from their capital and, in some cases, joining with like-minded asset owners on investments.

One novel approach is a joint venture formed last month by the Alaska Permanent Fund Corp., the Public Institution for Social Security of Kuwait and RPMI Railpen to invest in new private equity and alternative investment managers.

Wafra Group, which is owned by the Kuwait entity, is the investment manager.

Institutional investors have used a similar approach to invest in real estate with money managers and/or operators. For private equity, a joint venture will enable institutional investors to accomplish two goals: make direct private equity investments without building a large staff and create a direct relationship with new managers.

That should increase investor control and create better alignment between them and managers, officials from the institutions said. It should also help save on fees, a subject of keen interest across the industry.

Investing in alternative investments "is not a fair game," Ashby Monk, executive and research director at Stanford University's Global Projects Center, told the investment committee of the $231.6 billion California State Teachers' Retirement System, West Sacramento, on Feb. 7.

Mr. Monk moderated a panel discussion on ways to expand co-investment and direct investment in alternative investments.

"We have enriched Wall Street to the extent that is astounding" from fees paid by limited partners pursuing risk-adjusted returns, Mr. Monk said. As a result, asset owners worldwide — including CalSTRS — are now talking about shifting to new models that would generate returns in the private markets for investors while keeping them fully aligned with managers, portfolio companies and beneficiaries, he said.

All-weather vehicles

The joint venture is not the only example of institutional investors and managers tweaking the traditional private equity investment model.

BlackRock (BLK) Inc. (BLK) is shopping a new all-weather-type perpetual private equity investment vehicle with a $10 billion fundraising target that would own typically minority stakes in companies for a very long time. Investors would invest their capital immediately in the fund, which initially would invest the money in public securities in an attempt to better align investors' investments with their liabilities and eliminate the low returns of a private equity fund's early years.

Another example is the University of California, whose $10.8 billion endowment is developing a program to engage directly with startups based largely on discoveries made by University of California researchers as an investor and possibly a client, said Mr. Monk, who is an adviser to the program.

"Why not mentor startups that need to improve operations," he said during the panel discussion at CalSTRS. It will give the endowment a leg up in investing directly in global technology startups, he said.

Asset owners in the latest joint venture, dubbed Capital Constellation, plan to make a combined initial $700 million commitment. Over the next five years, Capital Constellation expects to invest a total of $1.5 billion with the additional capital coming from the original partners and/or possible other asset owners.

Alaska Permanent Fund Corp., the $65 billion sovereign wealth fund, and RPMI, which manages the assets of the £28 billion ($39 billion) Railways Pension Scheme, London, are committing $200 million each, said Stephen Moseley, director of private equity and special opportunities at the Alaska fund, Juneau.

The more than $100 billion Public Institution for Social Security of Kuwait is committing $300 million, Mr. Moseley said.

Asset owners have learned they have more to bring to the table than their deep pockets. "We believe that this collaboration will create a better outcome for all," said Paul Bishop, investment director at Railpen, wrote in an email. "In our view, the strategy of investing in the best emerging managers will perform well and combining this with the expertise, relationships and capital of three leading global institutional investors will deliver substantial, long-term value to our beneficiaries."

In exchange for their capital commitments to emerging managers' first funds, the three asset owners also get an ownership stake in the firms. Unlike commingled funds that take stakes in alternative and other money managers, the asset owners in this joint venture can establish a relationship with the new managers, allowing them to co-invest or commit more capital to a fund.

Establishing relationships

What's more, should a new manager turn into the next hot manager, the relationship is expected to be strong enough to reserve a spot for the asset owners' capital in future funds. And the joint venture has no expiration date; the investors can remain in the joint venture and in the underlying investments forever.

"This venture extends the reach of Railpen's private markets team, providing enhanced access to the next generation of successful private market firms," Mr. Bishop said. "We are confident that this innovative platform will become an important resource for first-time managers as they launch and build the next generation of successful and enduring private market franchises."

The $700 million "is the initial capital. We like to seed firms with at least $100 million of capital and we plan to put together a diverse portfolio of at least 10 promising private equity and alternative investment (general partners) over the next five years, which would bring us to $1.5 billion in equity capital," said Daniel Adamson, New York-based managing director of Wafra and president of Constellation, in an interview.

Alaska's Mr. Moseley said the unique partnership will help the permanent fund's relatively small alternatives staff invest in emerging private equity and alternative investment firms. Alaska Permanent's private equity and special opportunities portfolio accounts for up 13% of the sovereign wealth fund.

"We believe that first-time funds can perform well," Mr. Moseley said. "However, due diligence when investing in new managers is particularly important and extremely labor intensive."

"It's an unusual situation too," Mr. Moseley said. "We have heard lots of institutional investors talk about a desire to team up with others. ... This is an area where there is a clear benefit connected to teaming up."

The investment is also "scalable" in that Alaska Permanent could potentially co-invest with the emerging managers or make additional commitments to their funds, Mr. Moseley said.

Constellation already has made its first investment — $100 million — to the first fund of Astra Capital Management LLC, a private equity manager specializing in growth buyouts in the communications and technology services industries. Wafra funded some of Astra's first deals before the joint venture was created.

The benefit of Astra's new relationship with Capital Constellation is the value the institutional investors can bring in addition to their capital commitments, said Mark Johnson, co-founder and managing partner of Astra.

"We are definitely retaining our independence, and most importantly these are three great partners that know us well, will help us add value to our portfolio companies moving forward, and will help us tell our story," Mr. Johnson said. "For us, it's a very accretive partnership we think will allow us to do better deals and grow the firm more successfully."