private equity | Pension360

More Private Equity, Less Fixed Income For Germany’s Largest Pension Fund

Bayerische Versorgungskammer (BVK), Germany’s largest manager of public pension assets, indicated this week that some major allocation changes could be coming to the fund.

Among the changes: doubling its private equity investments (from 4 percent of assets to 8 percent) and trimming its fixed-income holdings (from 60 percent of assets to 50 percent).

From Bloomberg:

Germany’s biggest public pension fund plans to invest more in private equity and hedge funds and reduce its bond holdings as low interest rates curb returns.

“We started committing the first funds to private equity in 2007 and we are now beginning to reap the first rewards,” said Andre Heimrich, chief investment officer of Bayerische Versorgungskammer, in an interview in Munich. “There is still room for expansion and we could imagine doubling our share of private-equity investments.” BVK currently has about 4 percent of its assets committed to buyout funds.

[…]

“The current low interest rate environment will persist for some time,” said Heimrich, who took over as CIO from Daniel Just, now BVK’s chief executive officer, in February 2013. “In Germany, we even might not have reached rock bottom yet.”

As a result, BVK plans to reduce fixed-income holdings, such as government bonds and covered bonds, to about 50 percent of its investments from 60 percent at present, Heimrich said.

Heimrich also outlined his expectations for returns. From Bloomberg:

BVK invests in private equity through firms including Pantheon International Participations Plc, a British investor in leveraged buyout firms. The first investments have seen annual returns of more than 10 percent, Heimrich said.

That compares with an expected return of about 7 percent on infrastructure investments, where BVK has placed about 3 percent of its assets through specialized funds that hold stakes in the likes of airports, harbors, electricity meters and prisons.

“We would like to do much more, but there are way too few projects on offer,” Heimrich said. “It would be a perfect asset class for us due to its long duration and above-average returns.”

BVK expects an average return on investment of 4 percent this year, higher than the minimum needed to meet commitments to pensioners, currently at about 3.7 percent, Heimrich said.

Apart from investing in real estate funds, BVK has been providing direct lending to commercial real estate projects as banks left an opening in recent years. It provided about 190 million euros in financing for the so-called Silver Tower in Frankfurt in 2011, 300 million euros for Tower 185 in the same city in 2013 and 450 million euros for shopping center Mall of Berlin this year. Two global real estate investment trusts, in which BVK invested about 500 million euros this year, have returned more than 10 percent by the end of August, he said.

BVK manages $76.5 billion in assets for 12 of Germany’s public pension plans.

Study: Has a 400 Percent Increase in Alternatives Paid Off For Pensions?

A newly-released study by CEM Benchmarking analyzes investment expenses and return data from 300 U.S. defined-benefit plans and attempts to answer the question: did the funds’ reallocation to alternatives pay off?

The simple answer: the study found that some alternative classes performed better than others, but underscored the point that “costs matter and allocations matter” over the long run.

In the chart at the top of this post, you can see the annualized return rates and fees (measured in basis points) of select asset classes from 1998-2011.

Some other highlights from the study:

– Listed equity REITs were the top-performing asset class overall in terms of net total returns over this period. Private equity had a higher gross return on average than listed REITs (13.31 percent vs 11.82 percent) but charged fees nearly five times higher on average than REITs (238.3 basis points or 2.38 percent of gross returns for private equity versus 51.6 basis points or 0.52 percent for REITs). As a result, listed equity REITs realized a net return of 11.31 percent vs. 11.10 percent for private equity. Net returns for other real assets, including commodities and infrastructure, were 9.85 percent on average. Net returns for private real estate were 7.61 percent, and hedge funds returned 4.77 percent. On a net basis, REITs also outperformed large cap stocks (6.06 percent) on average and U.S. long duration bonds (8.97 percent).

– Many plans could have improved performance by choosing different portfolio allocations. CEM used the information on realized net returns to estimate the marginal benefit that would have resulted from a one percentage point increase in allocation to the various asset classes. Increasing the allocations to long-duration fixed income, listed equity REITs and other real assets would have had the largest positive impacts on plan performance. For example, for a typical plan with $15 billion in assets under management, each one percentage point increase in allocations to listed equity REITs would have boosted total net returns by $180 million over the time period studied.

– Allocations changed considerably on average from 1998 through 2011. Of the DB plans analyzed by CEM, public pension plans reduced allocations to stocks by 8.5 percentage points and to bonds by 6.6 percentage points while increasing the allocation to alternative assets, including real estate, by 15.1 percentage points. Corporate plans reduced stock allocations by 19.1 percentage points while increasing allocations to fixed income by 10.5 percentage points (consistent with a shift to liability driven investment strategies), and to alternative assets by 8.6 percentage points. For the DB market as a whole, allocations to stocks decreased 15.1 percentage points; fixed income allocations increased by 4.3 percentage points; and allocations to alternatives increased by 10.8 percentage points. In dollar terms, total investment in alternatives for the 300 funds in the study increased from approximately $125 billion to nearly $600 billion over the study period.

The study’s author commented on his findings in a press release:

“Concern about the adequacy of pension funding has focused attention on investment performance and fees,” said Alexander D. Beath, PhD, author of the CEM study. “The data underscore that when it comes to long-term net returns, costs matter and allocations matter.”

[…]

“Many pension plans could have improved performance by choosing different allocation strategies and optimizing their management fees,” Beath continued. “Listed equity REITs delivered higher net total returns than any other alternative asset class for the fourteen-year period we analyzed, driven by high and stable dividend payouts, long-term capital appreciation and a significantly lower fee structure compared to private equity and private real estate funds.”

Read the study here.

How Does Implementation Cost Affect Private Equity Performance?

A recent paper in the Rotman International Journal of Pension Management analyzes the costs and performance of private equity investments of large public pension funds.

There were a few interesting findings, but the authors admitted that the “most interesting” was how drastically implementation style affects performance.

The paper finds that “higher-cost implementation styles resulted in dramatically reduced net performance”.

But a larger problem is that this cost isn’t often adequately reported in financial statements. Further analysis from the paper, titled “How Implementation Style and Costs Affect Private Equity Performance”:

Our findings confirm those of other CEM research indicating that the highest-cost implementation styles have the worst net returns. We believe that since costs have such a significant impact on performance, fund managers should understand the true costs of investing in private equity. However, CEM experience indicates that costs are underreported in the financial statements of many funds. This is unfortunate, because what gets measured gets managed, and what gets poorly measured gets poorly managed. This underreporting is not intentional. In fact, the accounting teams of many funds believe they are reporting all costs.

The four most common reasons that private equity costs are underreported are the following:

• Accounting teams often rely on capital call statements to collect management fees. Yet these statements often show management fees on a net basis, whereby the management fee owing is offset by the LP’s share of transaction and other revenues (commonly called rebates) generated and kept by the general partner (GP). Therefore, accounting teams have no record of their share of the gross management fee paid to the GP.

• The repayment of management fees before the carry has been paid is treated as a reduction in cost. This is an accounting shift; no money is coming back. For every dollar of repayment, there is a dollar of carry.

• Carry (e.g., performance fees) is excluded.

• For FOF LPs, the costs of the underlying funds are excluded. The underreporting in financial statements is material. For example, the cost of private equity LPs is frequently reported to be less than 0.70% by funds’ financial statements, whereas Dutch funds that are beginning to collect and report all private asset costs are reporting a median of 3.03% (0.12% internal monitoring costs + 1.66% management fees + 1.10% carry or performance fees + 0.15% transaction fees. For a fund with US $5.0 billion in private equity assets, the difference between 0.70% reported and 3.03% actual represents US$116 million in costs.

There’s much more analysis available in the full paper, which can be read here.

Some Pension Funds Want Longer Private Equity Deals; Funds Bypassing PE Firms To Avoid Fees

Private equity investments typically operate on a five-year timeline. But some pension funds are talking with private equity firms about longer-term deals. And at least one pension fund is cutting out the middleman and buying companies outright to avoid fees.

Reported by the Wall Street Journal:

Canada Pension Plan Investment Board is “open to conversations” with private-equity firms about partnerships to buy and hold companies for longer than the traditional five-year investment period, said Neal Costello, a London-based manager at the C$227 billion ($203 billion) pension fund.

Blackstone Group LP and Carlyle Group LP are among private-equity firms exploring how they can do longer-term deals with investors such as CPP and sovereign-wealth funds, people familiar with the firms have said.

Such deals could represent a major shift in the private-equity industry. The firms may use their own balance sheets rather than their funds to buy large companies with investors, people have said.

[…]

Large institutional investors are balking at paying expensive private-equity fund fees, and they are seeking to hold investments for longer. CPP is already buying companies outright, in addition to investing in private-equity funds and taking direct stakes alongside those funds. Earlier this year, it bought insurance company Wilton Re for $1.8 billion.

“That’s a very long-term asset,” Mr. Costello said Thursday at a conference in London organized by the British Private Equity and Venture Capital Association. “We can look at a 20-year investment period.”

Universities Superannuation Scheme, a London-based pension manager of £42 billion ($67.6 billion), would also consider longer-term deals in partnership with private-equity firms, according to Mike Powell, head of the private markets group at USS Investment Management.

“If we find good assets, we want to hold on to them as long as we can,” Mr. Powell said in an interview at the conference.

USS has already bypassed private equity and other fund managers entirely: It owns direct stakes in London’s Heathrow Airport and NATS, the U.K.’s air traffic service. Investing directly in infrastructure projects and companies is a way of avoiding paying high fees to fund managers, Mr. Powell said.

One problem that arises with a longer timeline is the issue of fees; most pension funds would balk at the additional expenses that accompany PE partnerships longer than five years. From the WSJ:

An obstacle to doing longer term deals with private-equity firms is figuring out how to pay the deal makers for such transactions, Mr. Powell said. Private-equity firms typically charge an annual fee of between 1% and 2% and keep 20% of profits when they sell a company, a model that won’t work if assets are held for many years.

“How do we remunerate them over the long term?” Mr. Powell said. “That’s up to Carlyle and Blackstone to come up with the answer.”

Ontario Municipal Employees Retirement System, a Canadian pension manager, has stopped investing in private-equity funds to avoid paying their fees, Mark Redman, the European head of its private-equity group said at the conference. The pension fund is buying companies directly instead.

The switch will benefit the pensions of the Canadian workers such as firefighters and policemen by saving them money, Mr. Redman said.

“The amount of fees that we were paying out for a fund, 2 and 20 [percentage points] and everything that goes with that, was a huge amount of value that we were losing to the fund,” Mr. Redman said. “If we could deliver top quartile returns and we weren’t hemorrhaging quite so much in terms of fees and carry that would mean that we would be able to meet the pension promise.”

Pension funds might have some leverage here — Pension360 has previously covered how PE firms want more opacity in their dealings with pension funds. The firms have been upset about the amount of private equity information disclosed by pension funds as part of public records requests.

Photo by 401kcalculator.org

CalPERS Chooses Firm to Manage $200 Million Private Equity Commitment

CalPERS announced Wednesday that it had chosen a firm to run its new $200 million private equity emerging manager commitment. The firm: GCM Grosvenor.

From Reuters:

Calpers said the new program would launch by the end of the year via a fund-of-funds vehicle. The pension fund would also invest $100 million in AGI Resmark Housing Fund, LLC, a San Francisco Bay Area-focused multi-family residential apartment development fund.

Calpers considers itself a leader in developing and implementing newly formed firms or firms raising first- or second-time funds, called emerging manager programs. Since 2010, the pension fund has committed $900 million to these types of funds.

Grosvenor, a large independent alternative asset management firm, manages approximately $47 billion in assets and multiple emerging manager programs for large institutional investors, including public pension plans and corporate plans.

San Francisco-based AGI Capital is an emerging manager-led real estate investment company that focuses on enhancing communities while delivering strong market returns for investors and partners.

CalPERS has invested $12 billion with emerging managers since 1991.

Dan Primack: All Alternatives Are Not Created Equal

Pension funds have been receiving flak from all sides lately regarding alternative investments.

The criticisms have been varied: the high fees, opacity, underperformance and illiquidity.

But, outside of official statements from pension staff defending their investments, it’s not often we get to here from the people on the other side of the argument.

Dan Primack argues in a column this week that not all alternatives are created equal—and the fight against the asset class has been “oversimplified”.

From Fortune:

Hedge funds are considered to be “alternative investments.” So is private equity. And venture capital. And sometimes so is real estate, timber and certain types of commodities.

A number of public pension systems have increased their exposure to “alternatives” in recent years, at the same time that they either have curtailed (or threatened to curtail) payouts to pensioners. The official line is that the former is to prevent more of the latter, but many critics believe Wall Street is getting rich at the expense of modest retirees.

The complaint, however, generally boils down to this: Alternatives have underperformed the S&P 500 in recent years, even though many alternative funds charge higher fees than would a public equities index fund manager. In other words, state pensions are overpaying for underperformance.

Great bumper sticker. Lousy understanding of investment strategies.

The simple reality is that not all alternatives are created equal. Some, like private equity, are more tightly correlated to public equities than are others. Some are designed to chase public equities in bull markets without collapsing alongside them (that’s where the name “hedge” name from). Real estate is largely its own animal. Same goes for certain oil and gas partnerships.

Lumping all of them together because of fee strategies makes as much sense as arguing that a quarterback should be paid the same as an offensive lineman. After all, they both play football, right?

Primack uses New Jersey as an example:

For those who want to criticize public pensions for investing in alternatives, be specific. New Jersey, for example, reported alternative investment performance of 14.21% for the year ending June 30, 2014. That trailed the S&P 500 for the same period, which came in at 21.38% (or the S&P 1500, which came in at 16.99%). But that alternatives number is a composite of private equity (23.7%), hedge funds (10.2%), real estate (12.74%) and real assets/commodities (6.12%). The sub-asset class most tightly correlated to public equities actually outperformed the S&P 500 (net of fees).

Would New Jersey pensioners have been better off without private equity? Clearly not for that time period. Having avoided real estate or hedge funds, however, would be a different argument. But even that case is tough to prove until New Jersey’s relatively immature alternatives program experiences a bear market. For example, both hedge funds and the S&P 500 went red last month, but the S&P 500’s loss was actually a bit worse. And macro hedge fund managers actually had positive returns. Does that make up for years of the S&P 500 outperforming hedge? Likewise, should real estate performance receive an indirect bump from recent rises in venture capital performance, just because they are both “alternatives?”

Again, that’s a judgment call that should be based on voluminous data, rather than on knee-jerk anger that alternative money managers are getting paid while retiree benefits are getting cut. If alternative managers are helping to stem the severity of those cuts, then everyone wins. If not, then the state pension needs a change in policy. But, in either case, the specific alternative sub-asset classes should be analyzed on their own merits, rather than as one homogeneous bucket. Otherwise, critics may throw out the baby with the bathwater.

Read the entire column here.

Photo by 401kcalculator.org

San Francisco Pension Fund Votes Today On Whether To Invest in Hedge Funds

San Francisco Employees’ Retirement System (SFERS) will vote later today on whether to invest in hedge funds for the first time.

If the board votes “yes”, the fund will have the ability to allocate up to 15 percent of its assets toward hedge funds. Reported by Bloomberg:

The hedge fund proposal stems from a June meeting when staff recommended changes to the fund’s asset allocation and the board voted to take 90 days to study options. At a meeting last month, staff suggested shifting the allocation to invest 35 percent in global equity, 18 percent in private equity, 17 percent in real assets, 15 percent in fixed income and 15 percent in hedge funds, according to the [fund CIO] Coaker memo.

The retirement system administers a pension plan and a deferred-compensation plan for active and retired employees. Retirement members include those who had worked for the City and County of San Francisco, the San Francisco Unified School District, the San Francisco Community College District and the San Francisco Trial Courts.

Herb Meiberger, a commissioner and retirement board member, last month called for keeping hedge funds out of the mix. Hedge funds are complex, difficult to understand and carry high management fees, he said in a September memo.

“SFERS is a public fund subject to public scrutiny,” Meiberger wrote in the memo. It’s “one of the best-funded plans in the United States. Why change course?”

[…]

The San Francisco fund had $17 billion in assets based on market value and an unfunded liability of 15.9 percent as of July 1, 2013, a decline from 21.1 percent a year earlier, according to its most recent actuarial valuation report.

The chief investment officer of SFERS, William Coaker, recommended approving hedge funds in a memo this month.

“They have provided good protection in market downturns,” he wrote.

Some Private Equity Firms Want More Opacity In Dealings With Pension Funds

Private equity firms are growing uncomfortable with the amount of information disclosed by pension funds about their private equity investments.

PE firms are cautioning their peers to make sure non-disclosure agreements are in place to prevent the public release of information that firms don’t want to be made public.

Stephen Hoey, chief financial and compliance officer at KPS Capital Partners, said this, according to COO Connect:

“We had correspondence with a municipal pension fund relating to the Limited Partner’s inquiry regarding the SEC’s findings from our presence exam. We objected to our correspondence with the LP of matters not relating to investment performance including notes taken by the LP representatives being submitted to reporters under the Freedom of Information Act (FOIA). It is our communications with LPs other than discussions about performance metrics that we object to being in the public domain.”

Pamela Hendrickson, chief operating officer at The Riverside Company, said PE firms should know exactly what pension funds are allowed disclose to journalists. From COO Connect:

“GPs should make sure their LP agreements and side letters are clear about what can be disclosed under a Freedom of information request. GPs must comply with any non-disclosure agreements they have with their portfolio companies and information provided under the Freedom of Information Act should be restricted to ensure that the GPs remain in compliance,” said Hendrickson.

It’s already very difficult for journalists to obtain details and data regarding the private equity investments made by pension funds.

But PE firms are worried that the SEC will crack down on fees and conflicts of interest:

The SEC has recently been questioning private equity managers about their deals and fees dating all the way back to 2007. There is speculation the US regulator could clamp down on private equity fees following its announcement back in 2013 that it would be reviewing the fees and expenses’ policies at hedge funds amid concerns that travel and entertainment costs, which should be borne by the 2% management fee, were in fact being charged to end investors.

“The SEC is taking a strong interest in fees, and this has become apparent in regulatory audits as they are heavily scrutinising the fees and expenses that we charge. Following the Bowden speech, we received a material number of calls from our Limited Partners whereby we explained our fee structure and how costs were expensed accordingly. We also pointed out that our allocation of expenses was in conformity with the LP agreements, which is the contract between the General Partner and a fund’s limited partners,” said Hoey.

COO Connect, a publication catering to investment managers, encourages PE firms to use non-disclosure agreements to prevent the public release of any information the firms want to remain confidential.

Photo by Truthout.org via Flickr CC License

Strong Global Equities Performance Drives Ontario Pension Return

The Ontario Public Service Pension Plan (PSPP) returned 12.5 percent overall in 2013. But a new report from the Ontario Pension Board, which handles investments for the fund, gives more details on the performance of individual asset classes.

Strong global equities performance (37 percent return) drove the fund’s returns in 2013. Reported by Pensions & Investments:

In the pension fund’s annual report released Thursday by the Ontario Pension Board, which administers the defined benefit plan, global equities returned 37% last year, while Canadian equities returned 18%, compared with 35.9% for the MSCI World (Canadian dollar) and 13% for the S&P/TSX Composite indexes.

Real estate returned 12.9% vs. its custom benchmark’s 9.7% return; infrastructure, 12% vs. 0.9% for its custom benchmark; emerging markets equities, 5% vs. the MSCI Emerging Markets (Canadian dollar) index’s 4.3%; and Canadian fixed income, 1.8% vs. -1.2% for the DEX Universe Bond index.

Private equity, which returned 17.8%, was the only asset class to underperform its benchmark, which was 30.2%.

The pension fund’s asset allocation as of Dec. 31 was 28.2% fixed income, 23.7% developed markets equities, 15.5% emerging markets equities, 14% real estate, 8% cash and short-term investments, 7.6% Canadian equities, 2.5% infrastructure and 0.5% private equity.

The plan improved its funded status from 94 percent to 96 percent, according to the report.

The fund handles $18.9 billion of assets.

Report: Maryland Fund’s Below-Median Returns Coincide With Shift to Alternatives

The Maryland State Retirement and Pension System experienced a 14 percent return in the 2013-14 fiscal year. The fund’s then-Chief Investment Officer, Melissa Moye, touted the returns as “strong” – but a new report suggests not only that those returns were below-median level, but also that they were driven by a shift in investment strategy that put more money in alternative investments.

From David Sirota at the International Business Times:

According to [report authors] Walters and Hooke, a former Lehman Brothers executive, that shift [of assets to Wall Street] coincided with below-median returns for Maryland’s public pension system.

“Ironically, as the fund’s relative performance has declined, its Wall Street money management fees have risen,” the report says. “In fiscal year 2014 alone, the Maryland state pension fund paid out roughly $300 million in fees to Wall Street money managers. Over the past 10 years, these money management fees amounted to over $1.5 billion, according to the fund’s annual financial reports. Nevertheless this high-priced advice resulted in 10-year returns that were $3.22 billion (net of fees) below the median.”

If the fund had matched medianreturns for public pension systems across the country, “the state could have awarded 80,000 poor children with $40,000 four-year college scholarships,” Hooke and Walters wrote.

Maryland’s shift into alternative investments happened while the securities and investment industries made more than $292,000 worth of campaign contributions to Democratic Gov. Martin O’Malley, who appoints some members of the Maryland pension system’s board of trustees. Vice News has reported that the Private Equity Growth Capital Group is a financial backer of a 501(c)4 group co-founded by O’Malley. In May, Pensions and Investments magazine reported that the Maryland governor appointed a managing director of an alternative investment firm called The Rock Creek Group to head a state task force on retirement policy.

Meanwhile, the chief investment officer of Maryland’s pension system was recently appointed to a senior position in the U.S. Treasury Department overseeing public pension policy.

“Eliminating active managers, selling alternative investments, and adopting indexing for 90 percent of the state’s portfolio would ensure median performance,” his report concludes. “These actions would also save the state huge amounts in money management fees.”

Hooke has testified in front of lawmakers advocating the increased use of index funds in pension investments – a strategy that would have worked well the last 4 or 5 years, but one that offers little protection against market contractions.

Since 2008, Maryland has more than doubled its investments in private equity, real estate and hedge funds. Those asset classes made up 29 percent of its portfolio in 2013.

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