CalSTRS Increases Co-Investments and Private Equity Allotments

Co-investments are an increasingly attractive way for investors to avoid private equity fees.



At last Thursday’s board meeting, the $327.7 billion California State Teachers’ Retirement System (CalSTRS) decided to increase its percentage of assets allocated to co-investments, taking part in the growing co-investments trend that has been a source of success for both the pension fund and other institutional investors.

The new policy would allow co-investments to take up 2% of the Private Equity Program’s net asset value, which would be approximately $880 million. This is a 250% increase from the previous allotment to co-investments of $250 million.

“In the early 2000s, co-investing was limited to a small group of forward-thinking LPs [limited partners]. Today, many LPS have entered the market seeking the performance and cost benefits of no-fee, no-carry co-investments,” said Rob Ross, a private equity portfolio manager at CalSTRS, at the meeting.

Co-investments are a type of direct private equity investment by a limited partner (such as CalSTRS) into a company or business. These investments are usually made in addition to previous investments that were facilitated through a private equity fund. However, because the co-investment is a direct investment, the LP does not have to pay additional management fees on it.

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The lack of fees, combined with the opportunity to invest in the well-performing private equity sector, has made co-investments boom over the past few years. Private equity funds benefit from these partnerships as well since they bring an increase in capital flow.

John Haggerty of Meketa, a consultant to CalSTRS, explained at the board meeting how the co-investment space has evolved over time.

“Private equity firms used to pair up with other private equity firms to get these large deals done,” said Haggerty. “Now that the expertise exists in the LP community to do these co-investments, it’s much more preferable to do it not with a competitor but rather with a customer.”

Haggerty also believes that CalSTRS’s large size makes it well positioned to make a profit off the co-investing space. There are not many investors capable of making deals of the size that CalSTRS can, meaning that the pension would have less competition.

“There are more larger deals that are available,” Haggerty said at the latest board meeting. “The larger deals represent a unique opportunity to exploit some inefficiencies as there are fewer players in that arena.”

Margot Wirth, director of private equity at CalSTRS, also emphasized that while these new investments will be larger, the private equity portfolio would still maintain a diversified strategy.

“These will allow us to do bigger investments, but we would do bigger investments sparingly and with an abundance of diligence and forethought,” she said at the board meeting.

The pension fund took the first steps to increase its co-investment program back in 2018, with the implementation of CalSTRS’s Collaborative Model. Wirth said the current steps to increase co-investments are essentially just an extension of the model implemented three years ago.

“The revisions we’re recommending are just more steps along that plan,” she said.

At the board meeting, CalSTRS also increased its overall private equity allocation to 13% from 11% and reduced global equity allocation to 45% from 47%.

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The Case Against a Bear Market, Per Ned Davis

Stocks have had a rotten start this year, but they won’t get too much worse, the research firm says.



The stock market slump starting the year is a giant bummer.

The S&P 500 is off 7% from its Jan. 3 high, nearing the 10% threshold for a correction. Fear is widespread that the market is headed for bear territory (a 20% drop), given the Federal Reserve’s moves to boost interest rates, plus high inflation and supply-chain snags. Last week, the pessimists pointed out, the S&P 500 was down three of the five trading days, and Friday’s heartening 2.4% advance could easily be just another head fake, soon to be erased amid high volatility.

Fear not, says Ned Davis Research: A correction is quite likely, but not a bear. Then the market will resume its upward trajectory, the firm predicted. “The January market decline is thus better described as a stiff rotational correction than the start of a new bear market,” wrote Tim Hayes, the firm’s chief global investment strategist.

He noted that not all countries’ equities are doing this poorly. “If a cyclical bear was getting started, we would not expect such bifurcated performance,” Hays said. “Typically, in a developing bear, worries about a deteriorating macro environment spread globally, sending markets downward in sync.”

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He’s got a point: Britain, Singapore, and Hong Kong are all positive. And the MSCI All World Index ex-USA is off 4.9%, a much better showing than the US’s market. Among MSCI indexes, 17 are ahead this year, and 14 of them are in emerging markets (EMs), the report indicated. Examples: Nigeria, up 8.5% for 2022, and Brazil, ahead 7.4%.

Ned Davis’ in-house indicators don’t show that the market will descend to a bearish level. “Oversold with pessimism extreme, the major equity benchmarks have been testing Monday’s intraday lows this [past] week, apparently building a base to be followed by renewed rallying,” Hayes declared. “The global bull market uptrend remains intact.”

To bolster his correction-only thesis, Hayes argued that what has happened to once-dominant tech stocks underscores that the sector’s prices were simply too lofty to be sustained. And don’t betoken a pan-market dive.

“In bailing out of technology, investors have sold the sector that’s been the most overvalued and most prone to underperform when bond yields are rising,” he wrote.

Certainly, the Nasdaq 100, home to the tech leaders such as Apple and Microsoft, is in correction turf, down almost 13% from its November high, much lower than the S&P 500.

“And that makes it likely that the bad news has been priced in and that a bottoming process is under way,” Hayes contended. “The indicator mix is currently more consistent with the end of a correction than the onset of a new bear.”

How much the Federal Reserve will boost interest rates, which could crimp stocks, is a matter of much debate and trepidation. Hayes conceded that rates could mess things up and “could lead to warnings.” Some indicators that Ned Davis watches might then take a bad turn, he said.

But the chief gauge of market unrest, the CBOE Volatility Index or VIX, has yet to reach “the level that would add a bearish signal to the report.”

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