Growth reflects confidence in return outlook

Institutional investors are continuing to move capital into alternative investment and real asset sectors, with assets in infrastructure, private equity and real estate gaining in the one- and five-year periods ended Sept. 30.

Venture capital saw relatively modest gains this year at 4.9%, to $43 billion, according to Pensions & Investments' latest survey of the 1,000 largest U.S. retirement plan sponsors.

All but one of the 14 investors with venture capital portfolios of $1 billion or more witnessed gains, most in the double digits for the year. However, the consultant to the plan with the most defined benefit assets in venture capital, the $100 billion pension plan of the Washington State Investment Board, Olympia, has combined venture capital with growth equity since 2017. Washington State reported $4.4 billion in venture capital as of Sept. 30.

Overall, Pensions & Investments' data reflects an ongoing macroeconomic trend, industry insiders said.

"The private markets are taking share from the public markets," said Scott Voss, Boston-based managing director at HarbourVest Partners LLC.

Investors continue to turn to alternative investments because they believe they will get a higher return than in the public markets. Indeed, with private companies choosing to stay private longer for the last several years, private markets are getting larger, Mr. Voss said.

Among the defined benefit plans of the 200 largest U.S. plan sponsors, infrastructure assets increased by 18.1% to $33.9 billion during the year and 164.8% over the five years, while real estate rose by 6.1% to $355 billion and by 23.8% for the five years ended Sept. 30. The year-over-year growth of infrastructure was slower than last year's survey results, when assets were up by 24.2%, while real estate assets have increased at a steady 6% rate for the last three survey periods.

Real estate asset growth reflected in this year's survey are in line with returns. The NCREIF Property index was up 6.24% during the 12 months ended Sept. 30.

The top three real estate investors on this year's list are the $384.4 billion California Public Employees Retirement Association, Sacramento, with assets up 6.3% to $37.1 billion; $243.3 billion California State Teachers' Retirement System, West Sacramento, with a 13.61% increase to $34 billion; and $157.6 billion Texas Teacher Retirement System, Austin, up 18.15% to $21.7 billion.

The results for the private credit and debt asset classes tracked by Pensions & Investments' annual survey were uneven, all from small bases. Private credit exhibited the largest one-year increase, which rose 61.5% to $26 billion. Bank loans rose by 24.8% to $13.1 billion. P&I does not have five years of data for private credit and bank loans. Meanwhile, mezzanine debt was up 10% for the year at $3.3 billion but down 45% for the five years. Distressed debt was down for both periods, by 6% for the year and 24.3% for the five years, to $18.7 billion.

"Private credit has been a beneficiary of sustained quantitative easing and its popularity comes at the expense of traditional fixed income," said David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC. "Private credit usually generates higher returns than most traditional fixed-income products, and recent default and loss ratios have been minimal."

The two largest private credit investors in private credit had very different experiences in the year. Top ranked $41 billion Arizona State Retirement witnessed asset growth of 68.2% to $8.1 billion, while the private credit assets of second place $94.2 billion North Carolina Retirement Systems, Raleigh, dipped by 1.6% to $5.7 billion.

At the same time, private credit lenders in some cases have supplanted the need for mezzanine debt providers. And with the exception of energy and specialty retail industry sectors, the supply of distressed debt has declined in this environment, Mr. Fann explained.

While hedge fund returns were very slightly positive, overall hedge fund assets, direct hedge funds and hedge fund-of-funds assets all dropped in the year. Hedge fund assets overall fell 3.2% to $154.9 billion, direct hedge funds dipped 2.4% to $134.5 billion and hedge fund of funds dropped 8.1% to $20.4 billion in the 12 months ended Sept. 30. Only direct hedge funds grew over the five-year period, up 3.9%, compared to a 28.9% drop in hedge fund of funds and a 2.1% dip for hedge funds overall.

In the 12 months ended Sept. 30, 2019, the HFRI (Hedge) Fund Weighted Composite index was up 0.37%.

Meanwhile, private equity, buyout and venture capital each saw growth over both time periods. Private equity rose 9% in the year and 18.6% over the five-year period to $400 billion. Buyouts were up 5.1% in the year and 11.5% in the five years to $219.3 billion. Venture capital increased 4.9% in the one year and 22.5% over the five years to $43 billion.

Assets of the largest 13 venture capital investors on this year's list all saw their assets increase over the year, all by double digits but one.

The three pension plans with the largest venture capital portfolios were the Washington State Investment Board, with assets up 25.6% to $4.4 billion; Texas Teachers, with its portfolio increasing 14.6% to $4.3 billion; and the $162.5 billion plan of the Florida State Board of Administration, Tallahassee, up 13.8% to $2.8 billion.

The Cambridge Associates LLC U.S. Venture Capital index was up 14.81% for the one year and 13.28% for the five years ended Sept. 30. Cambridge's U.S. Private Equity index earned 7.74% for the year and 11.51% for the five years ended Sept. 30.

"Over the past five years, we were in a virtuous cycle for venture capital," Mr. Fann said. "The rise of 'unicorn' companies (venture capital-backed companies with valuations over $1 billion) caused many VC funds to significantly appreciate."

With good asset class performance, investors increased their investments, in effect, chasing performance, he said.

Some venture capital funds raised sizable late-stage growth-oriented funds, especially as many private companies delayed going public, Mr. Fann said.

The growing number of private companies staying private longer also helps to explain the increased venture capital exposure, Mr. Fann added.

U.S. venture capital fundraising in 2019 was the second-highest since 2006, according to the most recent quarterly report by the National Venture Capital Association and PitchBook Data Inc.

Some 259 U.S. venture capital funds raised a total of $46.3 billion in 2019. Last year was just under the record venture capital fundraising year of 2018, according to the report.

Over the last five years, several managers have raised very large venture capital funds. By far the biggest is the $19.6 billion China State-Owned Capital Venture Investment Fund managed by China Reform Holdings Corp. Ltd., a Beijing-based state-owned enterprise that closed in 2016.

Behind that fund are a number of managers that raised $3 billion-plus funds. Tiger Global Management raised two venture capital funds of $3.75 billion each, Tiger Global Private Investment Partners XI and Tiger Global Private Investment Partners XII, in 2018 and 2019, respectively.

The firm raised the capital just three years after it raised $2.5 billion for Tiger Global Private Investment Partners X in 2015, according to information from Preqin and Bloomberg reports.

New Enterprise Associates is also in the $3 billion club, raising $3.3 billion for New Enterprise Associates 16 in 2017, two years after closing on $2.8 billion New Enterprise Associates 15, Preqin data show.

The firm is currently raising a new fund, New Enterprise Associates 17, which has a $4 billion fundraising target, according to documents on the website of a fund investor, the $9.7 billion Sacramento County (Calif.) Employees' Retirement System.

Technology Crossover Partners closed on a $3 billion fund in January 2019, Technology Crossover Ventures X. The firm closed the predecessor fund, Technology Crossover Ventures IX, at $2.5 billion in 2016.