New analysis of U.S. pension plans' buyout portfolios reveals that the largest are not necessarily the most successful when evaluated for both risk and returns.
The $22.1 billion Los Angeles Fire and Police Pensions' $2 billion private equity portfolio ranked No. 1 on the inaugural list of 11 funds, achieving the highest average of its risk and return scores. The $11 billion private equity portfolio of the Florida State Board of Administration, Tallahassee, which oversees a total of $209.7 billion, including the $167 billion Florida Retirement System, was in second place, and the $26.8 billion private equity portfolio of the $351.5 billion California Public Employees' Retirement System, Sacramento, was third on the risk-return ranking.
HEC Private Equity Observatory, Paris, partnered with Pensions & Investments to conduct a transaction-level analysis of the risk and return of domestic asset owners' private equity portfolios. The initial analysis focused on U.S. buyout funds and uses data from London-based alternative investment research firm Preqin, methods by eFront and PERACS and analysis by Oliver Gottschalg, Paris-based associate professor at HEC.
The study aimed to assess the most successful private equity programs: portfolios that produce solid returns but would also perform well if the next financial crisis — such as another Great Recession — occurred in the next 12 months, said Mr. Gottschalg, co-founder and director of the HEC Private Equity Observatory.
Mr. Gottschalg and his team assessed the aggregate return score of each portfolio for buyout funds vintages 2004 through 2013. They also calculated the value at risk of portfolio on all active investments made by the funds to assess how each portfolio would do if the absolute worst happened, he said.
"As an LP, it is absolutely crucial to build a portfolio based on what could happen," Mr. Gottschalg said. Investors are in a tricky position; they could reduce risk by investing in more funds but that could increase costs and lead to lower returns, he added.
The study reveals that choosing funds based on characteristics of the expected underlying transactions would lead to a more balanced portfolio and the highest returns with the lowest risk, Mr. Gottschalg said.