Orange County Fund Aims to Lower Private Equity Costs

Orange County, California’s $11.5 billion pension is putting together a fund open to smaller retirement plans to give them access to private-equity investments at a lower cost.

The county selected London-based Pantheon Ventures LLP yesterday to manage the pool. For the past 10 months, Orange County’s Employees Retirement System has been collaborating with other California pensions to develop the fund, which would give them leverage when negotiating fees with private-equity firms.

Orange County, south of Los Angeles, plans to invest $50 million to $100 million annually over three years. It may save as much as $5 million a year in fees, more than the system pays investment staff, according to a memo. Pensions from California’s San Bernardino County to the state of Wyoming are considering joining the fund, according to officials at both plans.

“We’ve demonstrated the effectiveness of collective purchasing and economies of scale,” said Girard Miller, chief investment officer of the Orange County system. “The pension fund beneficiaries, stakeholders and taxpayers are all going to benefit.”

U.S. public pensions from California to Connecticut have piled into riskier investments such as private equity as they face a $800 billion funding gap on promises to retirees amid slow growth and lower interest rates.

Expensive Chase

Private-equity firms use borrowed money to buy companies, improve profits and resell them. The top 25 percent of private-equity funds delivered better returns than the Standard & Poor’s 500 stock index by 37 percent over the life of the fund, according to a 2011 study that looked at 450 buyout funds from 1984 to 2010.

Chasing those returns is expensive. Private-equity and hedge-fund managers typically charge 2 percent of assets they oversee, plus 20 percent of profits. Some small and mid-size pensions that are shut out of the funds with the best track records buy stakes in a pooled investment called a fund-of-funds, which creates another layer of fees.

“Most of these guys can only write $5 million checks,” said David Fann, president of TorreyCove Capital Partners, a San Diego-based firm that advises pensions on private-equity funds. “They’re very low on the list of priority investors. They just don’t have meaningful buying power.”

Money-management fees paid by Orange County, which has a 5 percent allocation to private equity, have more than doubled to $40 million over the last decade, according to the pension’s annual reports.

Pantheon Chosen

Orange County selected Pantheon based on performance, price, access to successful private-equity firms and the ability to customize portfolios, according to a memo from Miller to the pension’s investment committee.

“We did not want this to simply become a naive low-bid contest focused predominantly on price at the expense of total expected risk-adjusted returns,” Miller said in the memo.

Pantheon, which oversees more than $25 billion in private-equity assets, will charge fees on the amount of money the pensions invest rather than the amount of money committed, as is customary.

Retirement systems that commit to the Pantheon fund before a September closing will be eligible for discounts, according to the memo. Orange County will pay Pantheon fees of 0.26 percentage point to 0.55 percentage point on invested capital depending on the size of the pension’s commitment and the total size of the pool, Miller said. That compares with fees of 1 percentage point paid to Orange County’s current fund-of-funds managers.

‘Intense’ Process

“We are tremendously excited to receive confirmation of our appointment,” Kevin Albert, Pantheon’s global head of business development, said by e-mail. “The selection process was intense and rigorous. We are looking forward to getting to work.”

Orange County is best known in U.S. public finance for its 1994 filing of what was then the biggest municipal bankruptcy. The county sought protection from creditors after its treasurer lost about $1.7 billion on derivatives.

Orange County hired Miller as chief investment officer in 2012. He previously served as chief operating officer for Janus Capital Group Inc., the Denver-based mutual-fund company, and as a senior strategist for the PFM Group, a Philadelphia-based financial adviser to cities and states.

Complex Decision

One challenge for the venture is that individual pension funds have their own constituencies and may find it difficult to give up control, Fann said.

“When you introduce that level of complexity on the decision-making side, it’s hard to figure out whether they’ll be able to be like-minded,” Fann said.

Investments in alternative assets, which are harder to value and sell, more than doubled to 24 percent of public pension portfolios from 2006 to 2012, according to Cliffwater LLC, a Marina del Rey, California-based firm that advises institutional investors.

Pantheon’s USA Fund VII, a $2.3 billion fund-of-funds formed in 2006, returned 4.7 percent annually for the five years ending June 30, according to an annual report from the South Carolina Retirement Systems, which invests in the fund. The S&P 500 returned an annualized 7 percent in the same period.

Since inception, Pantheon VII has returned 7.6 annually, according to an investment report from the Kern County, California, Employees’ Retirement Association. Two other Pantheon funds from 2002 and 2004 returned 9.7 percent and 7.2 percent annually, respectively.

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