Two of the country's largest public pension funds might create captive general partnerships that will allow them to make small private equity investments.
The $102 billion California Public Employees' Retirement System, Sacramento, is considering a "captive vehicle" that would allow the fund to invest in venture capital partnerships, confirmed Hal Brown, investment officer for private equity and alternative investments.
Meanwhile, the $45 billion New York City Employees' Retirement System is considering a captive general partner for its targeted investment program, said New York City Deputy Comptroller John Lukomnik, who represents City Comptroller Alan Hevesi on the board.
At CalPERS, it will be September at the earliest before fund executives begin the process, said Mr. Brown, who discussed the proposal at a private equity conference in New York, sponsored by the Institute for International Research.
NYCERS is in the process of expanding its already successful targeted investment program beyond housing finance. But trustees have to approve an investment policy statement before deciding if a captured vehicle is the correct step, Mr. Lukomnik said in a separate interview.
A captive partnership works exclusively for the pension fund, evaluating and investing in deals. It is similar to a fund-of-funds, except the pension fund is a general partner - in tandem with a professional investment group - instead of a limited partner.
"It is essentially a fund-of-funds with a reduced fee structure," said Mr. Brown. "By virtue of our ownership, we will be part general partner of it."
Such a structure is favorable to CalPERS and NYCERS because large pension funds find it difficult to invest in venture capital partnerships and other strategies that typically raise no more than $100 million.
A $25 million investment is 25% of a $100 million fund, but a drop in the bucket for a large pension fund.
A 100% return on a $25 million investment has little impact on CalPERS' and NYCERS' total fund performance, but a loss, while also insignificant, nevertheless requires a disproportionate amount of the staff's attention.
Yet both funds realize there are opportunities to exploit.
CalPERS has little exposure to venture capital, which is part of the pension fund's partnership portfolio. Partnerships have an allocation of 3% of total assets, and CalPERS' has committed about $5 billion. The pension fund has invested about $2 billion.
"We want greater exposure to the venture community, but by virtue of the size of those funds, it is impractical to invest between $5 million and $15 million," said Mr. Brown. "We like to do bigger investments."
It is conceivable another large pension fund that wants exposure to venture capital may join with CalPERS, according to Mr. Brown.
"For a large fund which needs to put out large pieces of capital yet recognizes there are inefficiencies and opportunities in small-scale projects, a captive general partner may be a way to aggregate those small opportunities if the agency costs, which includes management fees, don't negate the opportunity," said Mr. Lukomnik.
"The other advantage for a pension fund that wants to do direct deals - some number of which will need hands-on expertise either for workouts or pre-workouts - is it enables you to have that expertise on board.
"That is not normally a capability present in pension funds.
"Finally, in the case of a targeted program, it provides another level of due diligence in evaluating specific deals, managing deals and realizing the best return upon exiting."
For all its benefits, the vehicle is "not a slam dunk," said Mr. Lukomnik.
"If you are amalgamating a lot of deals in different industries, most general partners don't have skills in all of those," he said. The pension fund also pays an extra fee, one to the general partner and one to the underlying partnership, said Mr. Lukomnik.
During the IIR conference, Mr. Brown elaborated on the progress of CalPERS' restructured private equity program. The pension fund in December allowed the staff to make direct private equity investments of up to $75 million without board approval.
The investment staff last week closed its third direct equity investment under the new structure, said Mr. Brown.
The direct investment program has a 2% target, or about $2.2 billion, said Mr. Brown. CalPERS invested about $600 million.
"That is the big area of emphasis," he said. "We will act as our own gatekeeper going forward. We want to get closer to those relationships that made money for us."
CalPERS' gatekeeper consultants - Hamilton Lane Advisors Inc., Philadelphia, and Pacific Corporate Group Inc., La Jolla, Calif. - will be phased out gradually as the pension fund builds up staff, said Mr. Brown.
Both firms assisted on the recent direct deals.
Hamilton Lane advised CalPERS on its investment in National IPF, which finances insurance for used cars; Pacific Corporate Group advised the pension fund on its investment in Century Fasteners, a supplier of industrial connectors.
"The consultants have done a great job for us," Mr. Brown said, but "we think it is important to be closer to the people producing value in the portfolio."
