Exclusive: With Five-year Returns Higher than 60%, New CIO Discusses Alaska’s Co-Investment Success

Art by JooHee Yoon

After achieving an annualized five-year return of more than 60% for the Alaska Permanent Fund Corporation’s (APFC) co-investment program, newly-appointed Chief Investment Officer Marcus Frampton sat down with CIO to discuss the program’s origins, how it has grown, and where it could head from here.

Could you describe your experiences in shepherding the origination and continuation of the co-investment program within the Alaska Permanent Fund Corporation?

Frampton: I worked for five years at Pacific Corporate Group with Steve Moseley doing co-investments. I had worked previously at Lehman Brothers on private markets transactions, but not specifically co-investments, and I came up in 2012 to Juneau and was hired specifically to build out our infrastructure co-investment program. At the time, we were doing private equity through fund of funds, and infrastructure was the one area where we were a direct limited partner in the funds.

The investment team of the APFC at the time was receiving co-invest opportunities in infrastructure but didn’t have the staff or the resources to evaluate and execute upon them. I focused on that for the first year in the capacity of Head of Private Markets and fairly early on hired Steve to help the APFC move from fund of funds in private equity to direct limited partnership investments, because you can’t co-invest if you’re not a direct investor in the fund. Then fairly concurrently we, led by Steve, started co-investing in private equity as we saw some deal flow right as we started moving away from funds of funds.

The most recent area we started working on was last year, when we started a co-investment program with our private credit funds. There can be a really fast timeframe on those deals, because of the nature of the process—the private equity firms tie up the transaction, then they bring the equity co-investors in, and the debt financing is one of the later pieces to be finalized. We’re co-investing with the debt manager that got selected, so that’s a higher volume of deals and a fast-paced process at the end of transaction timeline. Since we started nine months ago, we’ve funded six or seven co-invests with private credit firms. Our entrée into private credit co-investing required us to make a new hire; two years ago we brought on Senior Portfolio Manager Jared Brimberry, who came to us with a background of evaluating direct credit situations from JP Morgan.  Jared grew up around Anchorage and was interested in returning home to Alaska.

But right out of the gates, we did co-investments with private equity and infrastructure, and for the past seven years, about half of our time has been spent on co-investments—even though it’s probably 20% or 25% of the capital we put out.

Do you think somebody looking to start a co-investment program  should look into infrastructure or private equity first? Or does the quickness of the private credit program make it more welcoming?

Frampton: I think private equity is probably the best place to start—most funds have a bigger roster of private equity managers than infrastructure managers, and I think the key and success of the private equity program is to see a lot of opportunities.

I wouldn’t recommend anyone to start with private credit, just because the deals tend to move so fast. I think private equity makes the most sense to start with, and probably infrastructure close behind that.

Which sectors do you find the most opportunity in for co-investments? And does your expertise in this space now allow you to see, for private credit, the landscape of opportunities and deals in that sector?

Frampton: Private credit’s the area I like the most right now. Part of it is where we are in the cycle, we like being more senior in the capital structure on these deals—some are mezzanine opportunities but most are senior loans or uni-tranche. I think that infrastructure and private equity’s gotten a little bit more saturated in terms of the number of limited partners who are looking to co-invest there, so we do see a bit more unique deal flow on the private credit side right now.

Within infrastructure and private equity, there’s still areas that we’re really active in, for example, in infrastructure we’re less interested in transportation right now, because our house view is that we’re late in the cycle economically, and some of the valuations are getting stretched. So we’re spending a lot of time on power and midstream infrastructure opportunities.

And for private equity, it’s hard to paint with a broad brush, just because we have so many different relationships that are doing so many different things, but we’re generally looking for smaller market deals, and less of the mega-cap transactions.

But if I had to pick one, I would say private credit’s the most interesting area just because there [are] very few LPs doing that today.

Can you break down the exposure and returns for the different areas of your private markets co-investment program?

Frampton: The infrastructure program is the first area that we started co-investing in back in 2012, that portfolio is smaller than our private equity co-investment portfolio. Currently we have a little more than $500 million in exposure to infrastructure co-investments and a 22.0% since inception net IRR. As it relates to private credit, it is a relatively new program, but we do now have over $100 million of exposure and a since-inception IRR of over 10%. And, finally, the IRR on private equity co-investments has been 63.4% net, on about $1.6 billion of current NAV. So performance has been terrific across the board, but really eye-popping numbers for private equity and real value being added for APFC’s stakeholders; Steve Moseley has done a terrific job leading on this area.

Do you also invest with other pensions, and what is it like working with them compared to some of the other asset managers that specialize in the sectors that they’re trying to entice your co-investment capital towards?

Frampton: Most of the time, we invest in a transaction where there’s a sponsor or GPs leading. We closed one direct infrastructure deal in 2017 with a business called Generate Capital. Generate is a private company that owns a diverse portfolio of smaller infrastructure assets primary in the renewables and sustainable infrastructure areas. They raised $200 million  in preferred stock, about 18 months ago, and we contributed $100 million of the $200 million total raise; APFC was the lead investor in the transaction. There’s a pretty good club of co-investors that invested in it with us—Stepstone is one, and they in turn had a handful of clients. The Ontario Power Generation Pension Fund also participated, along with Activate Capital, who holds a board seat at the company along with APFC. So we’ve had some situations like that. Similarly, Steve Moseley on the private equity side led a series C round for a company called Indigo Agriculture that a number of investors came into.

We also have collaborated on other investments with state pension funds—we have a timber joint venture called Twin Creeks Timber, that’s with CalSTRS, Washington, Oregon, and Maine. The timber market’s been tough but that’s a great partnership. Through investments like that and just being in funds together, we have some good interaction with our peers. For example, many of the investors in Twin Creeks Timber are limited partners with us in Global Infrastructure Partners. So we see our peers at the annual meetings and compare notes on opportunities in the market, which provides a great source of market color.

Your team’s had good success so far with the co-investment program—how do you see the future of it playing out?

Frampton: The last seven years here have been a period where we’ve pulled off many instances of low-hanging fruit, like I said, when we started, we were mostly doing fund of funds in alternatives, and we’ve had some success in adding head count and building up these programs. I think we’re hitting the point where it’s very difficult to add additional head count because of the budget situation in the state of Alaska, and where the next leap forward would take adding more than one or two people just started trying to lead a lot of transactions.

So, I think our model is largely going to stay the same in terms of leading with fund investments and nurturing strong GP relationships, doing a lot of co-investing around those fund investments and then on occasion doing a lead direct deal like Generate or Indigo. That’s a great model, and our ambition is to keep growing private markets as a percent of the overall fund here.

Where we may be in terms of the cycle also has a major impact on the outlook. On this point, my view is that—and I don’t think this is controversial—market valuations are very high today in most areas, and we’ll likely enter a recession at some point in the next couple of years. So I think my greatest hope as CIO here is to enter that period with significant dry powder, and I think that’s when our co-investment program will be very valuable. When one makes a fund investment, it gets drawn over three years, but when one has a solid co-investment program and many great fund relationships, you can be in a position to hit the accelerator when times get really interesting. That’s my greatest hope.

Today, on the margin, we’re doing a little bit less on the deployment side, and we’re likely to enter the market with a very large secondary sale in coming weeks or months to free up additional dry powder. On the public market side, we’ve been trimming and we’re holding more cash. And so that’s how we want to be positioned, and I guess time will tell exactly if that plays out.

Is there a strong correlation in terms of beta with the co-investment program? Do you think market swings kind of dictate the return of that portfolio?

Frampton: I think people would be fooling themselves to think that private equity wouldn’t have some real beta in market downturns. In private equity, it’s well-known that the dispersion of returns between top quartile and bottom quartile managers are wide— in many cases, 1,000 basis points, so my first point is we’d like to get this type of outperformance in down markets as well as up markets. Second, we don’t try to make investments that are immune to cycles and it is likely that if the market goes to another ’08 type scenario, we’ll likely incur losses on our co-investment portfolio, but I think the people that are going to do the best are ones that are cycle-aware and are reserving capital to be aggressive with new deployment as well as support existing investments that need capital. There’ll be companies in our co-investment portfolio who need to raise capital at that point and we as investors need to have liquidity for them.

On this point, I think in the last cycle there were more than a few folks who were very actively co-investing for the first time in ’07, and then didn’t have the liquidity or were surprised by how things turned out in ’08 and ’09. As a direct investor, you need to be in a position to react, sometimes in a matter of days or weeks, if a portfolio company needs additional capital. And often there will be someone in the cap table who cannot participate due to their own issues and they get diluted at the worst possible time. We are very focused on avoiding this issue if things do turn.

So, I’m not under any illusion that there’s not beta in our portfolio, but I’m trying to make sure that we if we enter a situation like this that we have ample liquidity to support both existing portfolio companies that need additional capital as well as to be opportunistic with new investments.

What kind of advice would you give to other institutional investors who would be interested in creating their own programs? CalSTRS is right in the middle of creating its own through the collaborative model that was created by Stanford University researchers. What kind of advice would you give to pensions like them who they are looking to carry out their own co-investment programs? What do they need in terms of staff, time, education, etc.?

Frampton: I know some of the folks at CalSTRS and I think really highly of them. I don’t know CalSTRS CIO, Chris Ailman, all that well, but I do know Scott Chan, their deputy CIO, really well. He’s a great guy and very smart. I anticipate that they’ll be successful with what they’re doing. I don’t know all the details of the collaboration program that they’re developing, and if they have it outlined, we’d be interested in working with them because we think really highly of CalSTRS.

Generally speaking for investors, thinking about getting into co-investments, I think my primary advice is to diversify; this is the age-old advice for all investors, that diversification is the only free lunch in investing. Diversification in a co-investment portfolio can be difficult because the rhythm of new deals is different than buying stocks where you can diversify a stock portfolio in 30 minutes. In the early period of building out a program, not being too lumpy with capital invested in single situations is smart and I think helps make it easier to diversify over time. I also think a group getting started in co-investing should work hard to ensure that they have a diverse group of potential GP partners to work with and to focus on not being overly reliant on one or two GPs for deal flow.

When do you think is a good time to start deploying capital for co-investments? Is it maybe in a down market?

Frampton: If one has perfect hindsight, 2009 would be the best time! But, of course, that is not a realistic expectation. As I mentioned earlier, I feel like we’re late in the cycle, but one also has to recognize that building out a private market program is like steering a battleship. You can’t just say now we’re going to go all in. You have to build relationships, you have to be deliberate about studying the industries you’re interested in and pacing in capital over vintage years without trying to time the cycle.

The Canadian pensions have relatively advanced, mature programs that are focused on co-investments and direct investments. Have you learned anything from them?

Frampton: Yes, first off, I’m quite jealous of their resources and budgets. Their governments have been really smart to invest in those organizations and I think it has paid dividends for their beneficiaries. The marginal return on one additional person is extremely high when you’re starting from the point where we and many of the US state funds are. So we have to recognize realistically where we are. And for us, the hybrid funds and co-investment model is a really efficient way to do a lot with a little. So, I don’t think we would be at a point to replicate what some of the Canadian plans have done, but I think it’s a great long-term aspiration and maybe with education of our constituents, that’s something we can aspire to.

The Canadian pensions realistically though are not a model I want to emulate just because our resources are very different than theirs, but I certainly respect them as investors in the market and I think it’s smart what their constituents have done. With that said, I would put our track record up against any of them. I think that with the small team we have, we’re outperforming most or all of them in our core alternatives programs.

Why do you believe that many of the pensions in the US haven’t really adopted a co-investment program yet? And would you encourage them to create one?

Frampton: Everything is situation specific. I think for the smaller pension funds, it may not be realistic to have the staff and to recruit the right people. However, when we’re talking about the larger state pensions, almost all have the wherewithal to have one or two people focused on co-investments. I never want to tell someone else what to do and everyone has their own specific recruiting challenges, and travel challenge is another topic. But clearly the first step is to assess one’s own resources.

To have a co-investment program, you do need to be able to hop on a plane in a week’s notice to meet with a management team or to review a deal in the sponsor’s office—it’s just not the same to do it over the phone. To co-invest, you do need to be able to react pretty quickly and have access to attorneys to process the deal flow and other support resources. So I don’t think everyone is in that circumstance.

But I think probably at least most of the large US state plans are getting to the point where they do have those resources and I think they should be considering moving into the co-investment area.

You mentioned that some of the other smaller pension plans can’t really do co-investments, but your team is, despite its success, not an expansive, extensive army of investors. So why do you think that your program has matured so much, despite its small scale?

Frampton: I think it’s a pretty widespread practice now for people to be co-investing, and the same thing happened in ’06 and ’07 when a lot of new entrants came into the co-investment space. A lot of new entrants came in back then and are doing so today, and today it is actually pretty competitive for co-investment deal flow from private equity firms. The relationship piece is very important because if we have sponsors working on a deal on a tight timeline, they need to understand what your investment process is and they need to understand with what level of certainty at different stages you’re good for the capital. So, I think co-investing is a new market for many folks and appropriately many smaller pensions move deliberately into new areas, but co-investing is, in my view, attracting a lot of new entrants even if it there are still many smaller pensions still on the sidelines.

Finally, if a pension after assessing their own resources simply can’t see themselves putting forth the right resources, a very valid option is to work with a third-party service provider. Many of the traditional fund-of-funds and gatekeepers have solid co-investment businesses helping folks in this situation. At some point, APFC may be interested in sharing our resources and expertise on the co-investment side with smaller peer organizations as well.

So your success is more based on the maturity of your team and your relationships.

Frampton: Yes, it fosters a confidence when we say we can close on time and we can and conversely when we give a partner a quick “no” on an opportunity that doesn’t fit it similarly builds strength in the relationship.

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