(May 10, 2012) — With the California Public Employees Retirement System’s (CalPERS’) recent $500 million lump-sum allocation to private-equity firm Blackstone, ‘strategic partnerships’-however defined-are all the rage. Why?
“Funds like ours have huge advantages due, in part, to our size,” says Ash Williams, the eminently quotable Executive Director and CIO of the $159 billion Florida State Board of Administration and a peer, fund size- and sophistication-wise, of Joe Dear and CalPERS. “I stole this line from Britt Harris of Texas Teachers: ‘We’re large, we’re liquid, we’re long-term oriented, and we’re essentially unlevered.’ There are now a number of institutions that can say that-but it’s a small number.” These four attributes, Williams says, allow the fund to “use our size to our advantage to get into certain investments.”
These investments are increasingly referred to as ‘strategic partnerships’-but what does this nebulous nomenclature actually imply? “Generally speaking, it’s about aligning interests,” Williams says. “I see them as being in the position to take advantage of opportunities that may be transient, and not have to enter a specific investment vehicle to capture that-the opportunity could be gone by the time everything is in place. To the extent that we can be flexible to move faster, under an umbrella of due diligence that’s been done in advance, and have terms that benefit both the limited partner and general partner, that’s what we want.” Oftentimes, as with the case of CalPERS, this can lead to a sizeable stake handed over to a well-established alternative investment firm. But it can also mean another thing: actually buying an equity stake in your asset manager.
The most prominent such move as of late was Texas Teachers’ purchase of a slice of Bridgewater Associates, Ray Dalio’s alpha factory in Westport, Connecticut. Led by ex-Bridgewater employee and current Texas Teachers CIO Harris, the $250 million buy signaled numerous facts: Dalio was serious about an orderly succession, Texas was interested in putting large chunks of capital to work, and strategic partnerships-in the form of buying a stake in asset management businesses-were a trend.
It was a trend that started, arguably, with Florida. “At the State Board, we’ve been thinking about strategic partnerships for 30 years,” says Williams. “We developed an affinity for the idea of co-investments in early 1990s. We started doing them, and worked with Lexington Partners on private equity secondaries and co-investments and, with Lexington, helped establish their co-investment partners’ fund.” Lexington grew robustly, Williams says, as did Florida’s returns with them. “We then decided to make an equity investment with them in 2010,” he says. “This is a situation where we know them really well-we’re a major investor and continue to be-and felt comfortable. We liked it so much we bought it – like the razor commercial says. If you intend to be in for a long time, why wouldn’t you do it?”
Florida has in fact stayed away from the lump sum-type deal that others, including CalPERS and New Jersey, have recently entered. “We haven’t done what some others mean when they say ‘strategic partnership’-just handing over a large amount of cash to be invested at will, even to well-established, quality firms,” Williams says. “It’s something we’re working on-everyone is pitching this-and we’re considering it, but that’s it at this time.” But whatever way strategic partnership is defined, Williams, says, “people should look for an alignment of interests. Neither party can prosper without the other doing so simultaneously. You don’t want it to be fee driven, you don’t want an unintentional risk-exposure increase; what you want is something that allows you to efficiently put capital up alongside your partner. They gain scale by your capital; you gain their expertise and the participation in best-ideas portfolios.”
“In the end, scale brings the ability to be a large partner-we are able to get advantageous fees and terms,” Williams says. “Also, it allows us to enter attractive investment structures. It’s a term that’s in vogue now, partly because lots of institutions that were big players in less liquid fields aren’t as liquid as they used to be.” Because some large institutional investors face liquidity pressures and are scarred by the happenings of 2008 and beyond, Williams says, “it’s harder to raise capital than it’s been for most of the last 20 years for private equity and venture capital firms. From the standpoint of those industries, strategic partnerships solve a lot of problems. They have fewer partners-which is more efficient for them-plus some close relationship with sticky money. It’s generally not capital that will go out the door after two poor quarters, like some funds of funds did in Q4, 2008. That was like a strong Canadian tide-think Bay of Fundy tides, flowing out.”
What this all adds up to is this: Asset management firms, hungry as ever for sticky capital, are increasingly turning to public pensions for large allocations. In turn, these public pensions are realizing that they, and not the private equity firms that for so long looked down their noses at the ‘herding’ of these asset owners, hold the strongest hand. It was ever thus, some say-but now, more than ever, these pensions are taking advantage of their size, liquidity, long-term outlook, and lack of leverage.