Calpers Said to Enter Buyout Secondaries BusinessSabrina Willmer
California Public Employees’ Retirement System, the largest U.S public pension plan, has sold almost $6 billion in private-equity fund stakes since 2007. It is now moving to the other side of the trade.
Since late last year, the $260.9 billion pension plan has competed for fund stakes in eight transactions on the secondary market, where investors trade interests in private-equity funds originally sold by buyout and venture-capital firms, its first foray into such deals, according to a person familiar with the matter. Calpers plans to start directing as much as $600 million a year to purchase secondary holdings, depending on market conditions, said the person, who asked not to be identified because the plans are private.
Calpers joins at least a half-dozen investors, including Abu Dhabi Investment Council and Canada Pension Plan Investment Board, that have expanded direct purchases of secondary stakes in recent years as sales picked up after the 2008 financial crisis. For the investors, doing such deals on their own eliminates fees charged by the specialized funds that have controlled the secondaries market for more than two decades. For sellers of private-equity stakes, the increased competition is adding liquidity to an asset class whose biggest drawback has been that investor capital is locked up for a decade or longer.
“It is a good dynamic from the seller’s side because you have much more capital coming into the market with more competitive pricing,” said Brian Mooney, a managing director at Cogent Partners, which advises on secondary deals.
Secondary sales hit $25 billion last year, matching a 2011 record, as banks sought to exit investments to comply with new regulations and pension plans with too much money in the asset class sought to scale back, according to a report by Dallas-based Cogent Partners.
The greater competition has helped narrow the gap between bids and the value of fund holdings. In the first half of this year, private-equity funds received an average high first bid equal to 84 percent of net asset value, compared with 40 percent in the first half of 2009, according to data from Cogent Partners.
Private-equity investors, also known as limited partners, have long invested in secondary deals through funds dedicated to such transactions. Firms such as New York-based Lexington Partners LP and London-based Coller Capital Ltd. dominate that niche, while Blackstone Group LP and Carlyle Group LP have made acquisitions over the past two years to expand into that market. Collectively, investment firms have amassed more than $35 billion to make secondary deals, according to Cogent Partners.
Secondaries allow buyers to acquire holdings at a discount to market value. Buyers get to evaluate how the funds are performing before purchasing the stakes, making them less risky than a new private-equity pool that hasn’t started investing. Secondary transactions also help mitigate what is known as the J-curve, the drag that fees have on performance in the early part of a private-equity fund’s life.
Joe DeAnda, a Calpers spokesman in Sacramento, said officials weren’t available to comment on the pension fund’s secondaries program.
The move by Calpers and others allows them to bypass fees charged by investment firms such as Lexington and Coller. Secondary funds usually charge 1 percent to 1.25 percent on committed capital, on top of the fees levied by the underlying managers, said Edward Nelson, a fund-formation lawyer at Gibson Dunn & Crutcher LLP. The carried interest, or share of profit, to the secondary firms is generally 10 percent to 12 percent, said Nelson. A typical buyout fund charges a management fee of 1.5 percent to 2 percent and carried interest of 20 percent.
Calpers, which had about $42 billion in its private-equity program as of March 31, has bought secondary stakes in funds on a one-off basis since the late 1990s, although it hadn’t competed in auctions of collections of partnership interests. The pension fund, which deployed about $36 billion into private-equity holdings in the boom years of 2006 to 2008, subsequently pruned its portfolio.
Following those sales, Calpers has been taking a more dedicated approach to buying stakes on the secondary market to add holdings in funds it missed out after 2008, according to the person familiar with the pension fund. That approach includes a new committee that meets every week to discuss potential deals, changes to the pension plan’s policies so it can move faster on investments and maintaining an up-to-date database of funds and prices, the person said.
The pension plan has committed about $1 billion since the late 1990s to secondary funds from Coller Capital and Lexington Partners, according to its website. Calpers last allocated money to a secondary fund raised in 2007, and the pension fund intends to invest instead through direct purchases, the person said.
Canada Pension Plan Investment Board, which has led the way in direct secondary purchases, plans to deploy $10 billion into secondary deals in the next five years. CPP Investment Board, which started making secondary investments in 2007, expects to increase the number of professionals dedicated to such transactions to 20 from 12 in the next several years, said Yann Robard, vice president, head of secondaries and co-investments at CPP Investment Board.
Virginia Retirement System, whose first direct secondary purchase came in September 2011, has made four acquisitions totaling $214 million as of September, according to Patty Atkins-Smith, legislative liaison and policy analyst at the pension plan. Teachers’ Retirement System of the State of Illinois this year hired Cogent Partners, Park Hill Group LLC and UBS AG to advise on sales of fund stakes and direct purchases on the secondary market, as part of a plan to better manage the portfolio, said David Urbanek, a spokesman.
The State of Georgia will use the secondary market as it builds its fledgling private-equity program, according to Jim Potvin, executive director of the Employees’ Retirement System of Georgia.
“If you are paying expensive fees up-front, it raises the bar for returns you need,” Potvin said.
This year, Abu Dhabi Investment Authority hired Richard Chow from secondary firm Paul Capital Partners to help build the sovereign wealth fund’s direct secondary program. Chow didn’t return e-mails seeking comment.
Abu Dhabi Investment Council, which invests part of the Arab nation’s surplus financial resources, last year led an investor group to purchase a 1.5 billion-euro ($2 billion) portfolio of private-equity fund stakes from Lansforsakringar AB, a Swedish bank and insurer. Queensland’s QIC Ltd. snapped up the rest of the deal, making it the institutional investment manager’s first purchase of a secondary portfolio.
Institutional investors may lack the skills to put their money to work in a complex market, Andrew Sealey, a managing partner at London-based Campbell Lutyens & Co. Ltd., which advises on secondary sales, said in an interview.
“There is an appetite for participation in the secondary market, but many LPs don’t have the resources, nor in some cases the technical skills,” Sealey said.
U.S. public pension plans in particular face challenges as they typically lack the budget to hire staff and take more time to make decisions.
“While many U.S. pensions are active on the buyside, the vast majority have not yet tapped the buyside directly,” said Cogent Partners’ Mooney. “It is hard to turn the ship for some of these institutions and it is going to take a while.”
The pace of secondary deals slowed in the first half of this year, to about $7 billion from about $13 billion in the first six months of 2012. Limited partners have brought a number of large portfolios to the market, suggesting deals will accelerate. Cogent Partners estimates the volume of secondary transactions will reach as much as $20 billion for all of 2013 as sellers seek to take advantage of strong demand.
Teachers’ Retirement System of the State of Illinois is offering about $500 million in private-equity fund stakes for sale, two people with knowledge of the matter said. Florida State Board of Administration recently sold positions in 18 private-equity funds from 2004 to earlier, said John Kuczwanski, a spokesman. Ireland’s National Pension Fund is preparing to market about 600 million euros in private-equity fund stakes as it redirects investments to benefit the domestic economy, three people familiar with the matter said in October.
Mizuho Financial Group Inc., Japan’s third-biggest bank by market value, agreed to sell 250 million euros in buyout fund stakes to Ardian, the private-equity unit that spun out from AXA SA, two people familiar with the matter said in October.
The performance by secondary funds is appealing in an environment where 10-year Treasury yields are hovering near 2.5 percent, interest rates are at record lows and U.S. public pension plans are struggling to generate aggregate annual returns of 7 percent to 8 percent needed to meet their liabilities.
Secondary funds that began investing in 2010 produced a 26 percent median net internal rate of return as of March 31, compared with 9.5 percent for private-equity funds that started to invest that same year, according to data from London-based research provider Preqin Ltd. Secondary funds beat private-equity funds in all but one year in the decade ending 2010, Preqin data show.
“More active direct participation in the secondary market by large institutional investors is here to stay,” said Nigel Dawn, global head of the private capital advisory business at Evercore Partners Inc. “The market will need to adjust to this new force.”