NEW YORK -- Having finally reached their policy targets for private equities, two pension funds are trying to figure out how to cut back on future commitments without losing hard-won access to top funds.
The State of Michigan Department of Treasury Bureau of Investments is just a few million dollars shy of its 15% target allocation, after a history of falling far shorter, said Dave Turner, who runs the $7.2 billion private equity portfolio of the $50 billion fund.
"We now have $9.5 billion to $10 billion in commitments, but capital is being called twice as fast as distributions are being returned. We're going to have to determine at what level we have to stop," said Mr. Turner, director of alternative investments, during a panel discussion of investment trends at the Dealquest Private Equity Summit held by the Institute for International Research in New York last month.
The Lansing-based Michigan fund invests in 195 funds with 90 partnerships. It also holds 40 direct investments plus shares in 50 to 60 companies that went public. Some of those holdings are being sold to take profits.
Two-thirds of the system's general partners have sought commitments for new funds, Mr. Turner said. "Last year, those funds were targeted at $500 million, and now they're trying to raise $1 billion. No one has an answer about how to deal with this, particularly because there is pressure to keep a coveted position in a fund," he said.
The $2.6 billion Colorado Fire & Police Pension Association, Englewood, which has 4% of assets invested in private equity and 8% committed, faces a similar problem, said Bill Morris, chief investment officer.
"We want to reinvest with the successful funds, but like Michigan, we're getting close to our allocation cap, so are cutting back," he said.
The system's private equity portfolio, which is managed by investment advisory and investment firm Pacific Corporate Group, Inc., La Jolla, Calif., has 35 to 40 partnerships.
The scenario is somewhat different at Lucent Technologies Inc., Murray Hill, N.J. On July 1, 1999, $63 billion in pension assets moved over to Lucent from AT&T Corp., which had spun off Lucent four years earlier. With the move, Lucent inherited 320 private equity partnerships. The pension plan now has commitments to 370 partnerships.
"About $5.5 billion is committed between domestic and international partnerships, and $4.2 billion has been invested," said David Landau, manager of private equity for Lucent.
Two-thirds of the partnerships are venture capital funds, while one-third are buyout funds; but two-thirds of invested capital is in buyout funds, while one-third is in venture cap.
Lucent is considering new partnerships in most categories of venture, buyout and special situation funds, except mezzanine funds, he said.
Like Michigan and Colorado, Lucent has been under pressure to recommit to its general partners' new funds, Mr. Landau said, adding that if the pension plan misses an opportunity to go into a fund, it may not get another chance.
When selecting a fund, he wants to know if it has the capacity for a superior better than 30% internal rate of return. "We look for credibility of the people and credibility of the performance. We always make a judgment about a team. How dependent are they on the leaders? What skills do they have? Do they complement each other? We like them to have a blend of financial and operating skills. How long have they worked together? What is their operating style?"
Michigan's Mr. Turner pointed out that as more and more buyout funds start technology portfolios or separate technology funds, "a higher standard is needed to evaluate them."
Lucent's Mr. Landau concurred. "Even when buyouts focus on `old economy' companies, technology can enhance them. I'm leary of funds carving out 20% to put into Internet investments if they have no track record there. I prefer a fund to stick to its core industries and harness technology to make industrial companies work better." That's the strategy used by buyout firm Clayton, Dubilier & Rice Inc., New York, and it's been successful, according to Mr. Landau.
As part of the panel, the pension fund officials also cited their likes and dislikes in dealing with general partners. Among them:
* Don't delay bad news or minimize it. "Let us know what you're doing about a bad investment. Tell us about litigation up front, not in a quarterly report," said Colorado's Mr. Morris.
* Don't just send a capital call; say what the money is for.
* Provide good information on valuations in quarterly reports and offer timely information on the status of each investment instead of waiting for the beginning of the next quarter.
