Rhode Island Is Ready and Willing to Buy Your Fund Commitments

The Rhode Island State Investment Commission has approved a new measure that would allow it to purchase secondary interests in LP fund commitments, with the purpose of allowing the commission more flexibility to build out its private growth portfolio to align with its new 15% target.

The commission said it expects its private growth segment to be the “overall portfolio’s highest return generator over the long term,” so it extended the target from its previous 6.5% in 2016 to become a more robust investor in the space, subsequently stimulating approval of the new secondary investment approach.

It would allow the institution to be more diversified in terms of sector and geography, a spokesperson told CIO, part of which is necessary since there’s a relatively heavy allocation to buyout strategies in the portfolio. It’s been the best-performing asset class to date (net of fees) over most time horizons.

The recently implemented pacing plan calls for about 10 private equity commitments per year, with each being between $20 million to $60 million, the spokesperson added, during what is said to be a contemporary “five-year ramp-up” period. The portfolio’s anticipated composition is illustrated here:

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“Many high–quality funds are hard to access,” Rhode Island said. “If [the commission] is able to get into such a fund via a secondary transaction, that can be an alternative way to gain such exposure. Additionally, GPs prefer to have consistent investors across fund vintages so the secondary may provide access to new funds with the high–quality GP on a primary basis.”

The commission also discussed the possibility of capitalizing on certain situations where an LP may be forced to liquidate its positions at deep discounts. “These may not be funds [the commission] would commit to on a primary basis, but the discount on the current portfolio and potential upside of the unrealized investments is attractive enough to warrant investment,” it said.

Overall, the institution is doing generally well with its $287 billion portfolio, having just recently outperformed its 3.60% benchmark and pulling in 4.14%, earning the fund $323 million. The returns were mostly fueled by the fund’s investments in the global stock market, which were mostly low-fee index funds.

The fund is currently leading a class action lawsuit against Google for failing to disclose security breaches the Google Plus social media platform had executed.

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GP-led secondaries had a record-breaking 2018, but new guidelines from ILPA show that investors want more information and more time to consider the deals.

GP-led secondaries deals hit a record $22 billion last year, the highest volume ever recorded, according to data from Lazard Freres & Co. Sponsor-led deals continued apace in 2019, with Collier and Investcorp coming together on a $1 billion transaction in January, followed by Nordic Capital executing the largest-ever GP-led deal in March. If sponsor-led deals were once indicative of trouble, the stigma surrounding this part of the secondaries market has all but disappeared. But now it seems investors want to pump the brakes and get more information.

GP-led secondaries typically occur near the end of a fund lifecycle when firms want to extend an investment period to realize greater returns or give investors the option to exit. In the past, these transactions have been indicative of bad bets, or so-called “zombie funds” with struggling companies that can’t be exited for one reason or another. Today, GP-led deals are becoming more common as sponsors move to have greater control over when they exit portfolio companies. LPs can benefit from increased liquidity as well as the ability to exit manager relationships that may no longer be core to the portfolio.

Eric Albertson, senior investment director, private equity and private markets at Aberdeen Standard Investments, says the secondaries market has evolved significantly over the past decade. It started with LPs becoming more aggressive about portfolio management, using the secondaries market as a means of pruning manager relationships or buying into otherwise closed funds. More recently, Albertson says, “GPs have woken up to the fact that there is a solution for them and so you’re seeing a big wave of GPs being more active with their portfolios.”

Albertson notes that the secondaries market generally is really a source of innovation in terms of all parties being able to more effectively manage liquidity in what is otherwise an illiquid asset class. “This is how you create a win-win,” he says.

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However, new guidelines from the (ILPA) Institutional Limited Partners Association suggest that investors may want to slow things down a bit. Earlier this month, the ILPA released new guidance for investors on GP-led secondaries with the goal of standardizing the process whereby investors are made aware of fund sponsors’ desires to change things up. ILPA is calling on private equity to ensure that sponsor-led restructurings are fully transparent and that investor advisory committees have enough time to consider the transactions before they are expected to act. The association also wants investors to be able to keep their original fund terms in place and be made aware of any changes in fees if they choose to roll over their investments.

“Transparency helps everyone get comfortable with the transaction,” says Steve Hartt, a principal in the Private Markets Group at Meketa Investment Group. He notes that GP-led restructurings can be complex and conflicts can arise for investors if parties aren’t aware of all of the information before they act.

By seeking to standardize the process, ILPA may be making things easier for both investors and GPs. “GP-led transactions are always going to be a part of the marketplace and if you can reduce the friction costs of the transaction and standardize information, it will help make the market more efficient,” Hartt said.

ILPA also plans to include the new guidelines as part of its Principles 3.0 document, set for release later this quarter.

Tags: ILPA, Private Equity, secondaries