Sidebar to the cover story: The new relationship between pension plans and private equity managers. Kip McDaniel reports.
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Like fishermen the world over, every asset manager dreams (and brags) of bagging The Big One. For these firms, there are no bigger ones than the public pension plans that inhabit state capitals across America’s vast expanse—and the past year has seen them bag some big ones indeed. Both fisherman and fish are labeling their newfound unions “strategic partnerships” or “strategic relationships”—which is pension-code for “getting a good deal,” or, perhaps more crassly, “making ourselves feel better about paying millions in fees”—and they are coming in various forms.
At their most simple, these partnerships are a lopsided exchange of information: Pension fund X will give hedge fund Y a significant capital allocation, expecting to be let in on the firm’s internal research and for someone to promptly answer the phone when they call. This style of relationship, while not new, dovetails with the nomenclature of those seeking to gather institutional assets—it is not “product,” but “solutions,” that they wish to sell to pension funds. Asset managers such as Bridgewater Associates have been doing this for years, of course—which, considering Ray Dalio’s success at both return generation and asset gathering, explains why others are so keen to do it now.
What America’s largest public pension plans are doing now, however, goes beyond this arrangement in two distinct ways. The sexier of the two is epitomized by the aforementioned Bridgewater and its new partial owner, the $101 billion Teachers Retirement System of Texas. Borne of the past relationship between Teachers’ CIO Britt Harris—before he moved to Austin, he was briefly the CEO of Bridgewater—and Bridgewater founder Ray Dalio, this past February saw the pension invest $250 million in the firm. (According to the pension, Harris officially recused himself from the Bridgewater deliberations months before the purchase in order to have an “objective” due diligence process. Deputy CIO Jerry Albright led the deal through its final stages.) The $160 billion Florida State Board of Administration, led by Ash Williams (see page 22), has made a similar move with New York-based Lexington Partners, a firm with which it has a long-standing relationship. And why not? If a pension fund truly believes in the persistent ability of one its managers to capture alpha, it makes complete sense to buy a stake in the expected continued success of that firm.
But while these clubby deals may seem sexy (well, as sexy as asset management can be), they are not on the leading edge of strategic partnerships. That title goes to the recent arrangements made by the public employee pension funds of New Jersey, California, Texas (Harris has been quite active), and a handful of others with the likes of Henry Kravis’ KKR and Steven Schwartzman’s Blackstone. Where these pensions once gave hundreds of millions to an individual private-equity firm, they are now giving billions—and it’s not just for private-equity investments.
“Hedge funds, private equity, real estate, commodities—Blackstone is top-quartile in all four of these areas, not just one,” New Jersey CIO Tim Walsh told aiCIO in May, following the fund’s $2.5 billion commitment to the firm. It wasn’t New Jersey’s first allocation to Schwartzman’s behemoth, but it was arguably its most important. “We call it a strategic relationship, not a partnership,” he said. “We use the relationship as an extension of our staff. There is only so much we can do with limited resources and manpower.” They are, Walsh asserted, a “source of investment opportunities around the world” and across their different specialties, and the trust New Jersey has put in them to act quickly is a result of years of relationship building. “It’s important to note that they weren’t soliciting us—we were previously big investors with them and we fine-tuned this relationship over time.”
Walsh is by no means an unthinking cheerleader for these arrangements. While he likes the ability to access opportunities that may not naturally arise within the relatively slow-moving public pension board approval process, “the interests just have to be aligned. What doesn’t get a lot of press is ‘what’s the alignment?’ Do private equity firms have skin in the game? If they have their own capital invested, there is no better alignment of interest.”
What public plan officials won’t say—or at least say too loudly—is that these deals are structured partly to circumvent American public plan governance. It’s cliché, but clichés often carry kernels of truth: ex-American plan design allows more CIO freedom via expert boards that are removed from the political process than their American counterparts. By allocating—skeptics would call it outsourcing—significant amounts of capital to an asset manager who will in turn take some control over tactical decisions, these American plan investment boards are being removed from the process on some level. Democracy is good only to a degree, it seems.
This isn’t the first time pension plans have invested large sums of money with a single private equity manager. Oregon’s pension system “did it a decade ago with KKR, committing $1 billion,” according to interim CIO Mike Mueller. But the explicitness with which these firms have been told to take full advantage of current market inefficiencies such as distressed debt and mortgage-backed securities is new. Add in the critical mass of state funds from Alaska, California, Texas, New Jersey, and others, and you have a trend—one that, hopefully, will allow these funds to avoid the critics’ most dour forecasts.