Big U.S. pensions are pushing deeper into private equity, seeking exclusive deals alongside buyout firms and at sweeter terms.
Texas and California teachers are ramping up their allocations to co-investments, with more staff and new offices dedicated to buyouts. And Calpers, the largest U.S. pension, discussed this week whether to take a bolder step and do deals on its own.
Public pensions already pour billions into buyout funds of firms like KKR & Co. and Blackstone Group LP and have been rewarded with a median annual return of 11.9 percent. Co-investing, in which pensions buy direct stakes in companies alongside buyout funds while paying little or no fees, promises even bigger gains.
But it also requires building what amounts to an in-house buyout team to vet deals -- an expensive endeavor that some public pensions, which are overseen by cost-conscious boards, have been hesitant to take.
“To do it well and at scale, you almost have to be a professional investor because you can’t rely on public information or market rules,” said Ashby Monk, executive director of a finance research center at Stanford University. “You’re doing corporate due diligence, meeting fiduciary standards. That’s the hard part.”
Public pensions in Canada were among the first to jump into the strategy, investing in companies such as department stores and software producers either on their own or alongside private equity giants. As early as in the 1990s, the pensions began establishing deal teams, backed by their professional boards’ willingness to pay top dollar for talent in Toronto and New York.
Deal Competition
Since then co-investing has spread in the U.S., with endowments and foundations as well as pensions angling for deals. And with buyout firms sitting on more than $1 trillion in dry powder awaiting asset prices to fall, there’s a lot of capital chasing a limited number of opportunities.
“There are so many LPs having the same idea at the same time, it’s making the competition harder,” Margot Wirth, director of private equity investing at California State Teachers’ Retirement System, told her board in Sacramento in January.
For Calstrs, which manages $224 billion in assets, the savings on fees makes the gamble worth it. Pensions typically pay a 2 percent management charge and 20 percent of gains when investing in a traditional buyout fund.