US pensions face Gulf funds for first blow on EP deals

(Bloomberg) — It took Scott Chan two years to convince his bosses at the California Teachers Retirement System to free up more money for profitable investments alongside the world’s largest private equity firms.

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In the time it took Calstrs’ deputy chief investment officer to build his case, the quickest and most nimble investors, mostly Middle Eastern sovereign wealth funds, netted more than $38 billion from such deals.

US pension funds, long among the most coveted clients for buyout firms, are rapidly losing ground to wealthy, deep-pocketed Middle Eastern sovereign funds. This is especially true in deals known as co-investments, where private equity managers use favored investors to put more money into individual acquisitions without huge fees. Sovereign wealth funds such as Abu Dhabi Investment Authority and Mubadala Investment Co. have seized such opportunities, dishing out billions to help broker private equity deals in recent years.

The increased competition for such deals comes just as they are becoming a more important tool for US pensions to save on management fees and bet on higher returns. This is changing the dynamics of how American pensions are invested, public fund executives say. The biggest US pensions are kicking into gear, revamping decision-making processes that have made them slow to evaluate new investments and increasing allocations to capture more of these deals.

The board of the largest US pension fund, the California Public Employees Retirement System, or Calpers, has given its investment team permission to make decisions within 48 hours if needed. At Calstrs, which manages roughly $338 billion, Chan persuaded the fund’s board this year to adjust an existing co-investment program to be more flexible and put more money to work.

Pensions are trying to move much faster now that big sovereign wealth funds are in sight, said Marcus Frampton, chief investment officer for the $78 billion Alaska Permanent Fund. The fund made 50 co-investments in the past decade and last year decided to expand its private equity team to do more such deals.

US public pensions, managed on behalf of teachers, firefighters and other public sector workers, have for years invested in private equity funds as a means of generating strong returns with less volatility than in equity markets public. The goal is to close a funding gap that has left many of them with tens of billions to cover expected retirement benefits.

But the asset class is expensive. Some US pensions spend roughly half a billion dollars on private equity management fees annually.

In recent years, US pensions have increased co-investment to gain exposure to attractive companies in a portfolio of funds, with zero fees to pay. Calpers, which manages about $490 billion, raised its private equity target allocation to 17%, in part to move more money into these co-investments. The pension became the largest just last year, investing $750 million in an undisclosed US buyout deal.

Access to these deals often goes hand in hand with a private equity firm’s future fundraising commitments. Meanwhile, private equity firms benefit from having a partner who can bear some of the risk from the outset, rather than facing all of it themselves.

The entry of giant sovereign wealth funds from the Middle East has brought a complication. US pensions have historically taken weeks or even months to make an investment decision, hampered by a cumbersome process involving investment committees, consultant reviews and political battles over the stewardship of pensioners’ money. In contrast, the likes of ADIA and Saudi Arabia’s Public Investment Fund can transact large sums quickly sometimes in hours.

“We needed to streamline all of the organization’s operations to become agile so we could compete in the market at anyone’s speed and scale,” Chan said in an interview with Markets Group in March about the funds’ efforts. to improve its co-investment strategy. If we were to do a co-investment, we should make sure to respond on the same day.

Calstrs saved $185.5 million in fees in 2022, helping strengthen Chance’s case. It now aims to make a co-investment for every fund investment it makes.

Calstrs can provide quick turnarounds on co-investment decisions and the ability to put down significant amounts, Mindy Tirapelle, a Calstrs spokeswoman, said in an emailed response to Bloomberg’s questions about pension fund co-investments.

Calpers declined to comment.

While US pensions are not new to co-investing, they have typically invested capital at a slower pace and in much smaller amounts than their sovereign wealth peers, which have grown at breakneck speed in recent years. .

The 10 largest Middle East sovereign wealth funds manage a collective $4.5 trillion in assets, coming closest to the amount managed by the 10 largest public investors in the US, Australia and Canada combined. That means they have big investment targets to meet, which in turn is pushing some deals into the multi-billion dollar range.

KKR, EQT and Brookfield all turned to Middle Eastern sovereign wealth funds last year to help fund big-ticket deals. And Apollo Global Management Inc. Chief Executive Marc Rowan said in February that the best investors are now in countries such as Singapore and the United Arab Emirates.

The first people to get calls about some of these deals, especially the bigger deals, are the people who can write a billion-dollar check on a deal, said Michael Lazorik, director of principal private equity investments at the roughly $200 million Teacher. Retirement System of Texas. This is a small number of people.

That means that over the past eight years, Lazorik said, investors also known as limited partners, who can commit to backing a 10-figure deal, have created a new level for themselves. In that time, the Gulf countries have pushed reforms in business policies and made other efforts to diversify their economies away from oil.

Saudi Arabia’s Vision 2030 program, launched in 2016, has fueled the kingdom’s aggressive investment strategy in companies abroad. Crown Prince Mohammed bin Salman has said he wants to make investments the source of government revenue, not oil. Instead of keeping much of their oil wealth in safe assets like cash, bank deposits and US debt, sovereign wealth funds are increasingly pouring money into investments in stocks, real estate, infrastructure and private capital.

Larger deals are now co-signed with private equity firms and are involved much earlier in the investment process than was the case historically. Canadian and Australian public pension funds, as well as Singaporean sovereign wealth funds GIC and Temasek, have been at the forefront of this type of investment and may continue with Middle Eastern players and in some cases, when a deal becomes too expensive. great, partner with them.

This has pushed some US pension funds into the so-called second tier. They get calls later, after a deal is signed, so they can buy sales, parts of investments that larger limited partners don’t want to hold.

Not every buyout firm has relegated American pensions to second place. Some have responded by creating an alternate system in which they offer access to deals first. However, more often than not, it’s about finding the money quickly and avoiding too many investors to negotiate the terms of the deal.

A large pension investor said some money managers prefer a limited partner that has tight governance, as it forces more questions about a transaction and thus adds a level of comfort to the viability of the deal itself. Many of the Middle East players are organized to write big-ticket deals, but the speed of such deals leaves less time for due diligence compared to the established limited partners approach, this person said, citing conversations with investment firms and partnering experiences with those players.

However, US public pensions, which collectively manage several trillion, are beginning to say that they too can be nimble and move quickly, and that they are reliable long-term partners. Some of the biggest ones still compete head-to-head with sovereigns in some deals.

It’s very difficult to get a position in a private equity industry like LP, and it’s even more important to maintain that position, Lazorik said. To maintain access to co-investments, limited partners often must make promises of substantial commitments in a private equity firm’s future fundraising. As sovereign wealth funds and investment firm fund sizes grow, few US players can keep up.

Calstrs says its new policy makes them more competitive against rivals, letting the fund commit to very large deals that other US investors wouldn’t be able to because of allocation constraints. Their ultimate goal is to co-lead the deals, taking up to 49% ownership in the company and grabbing supervisory board seats.

The biggest U.S. pension funds privately acknowledge that they have seen the rise of sovereign wealth funds over the past decade and how that has affected their access to investment managers, according to people familiar with the matter who asked remain anonymous by discussing strategies that are not public.

Some of them even see trying to compete with Middle Eastern funds as an exercise in futility.

Calpers invests $7.5 billion to $8 billion a year in co-investments, up from just $3 billion in 2022. This year it decided it no longer plans to invest that money with the big-name private equity shops that run successful deals and gain strong competition with sovereign wealth funds.

Instead, Calpers is shifting its money to smaller managers and deals that may be less competitive. While the pension made that decision primarily to diversify its portfolio, getting meaningful withdrawals with those funds is another benefit. As one person in the know said, Calpers wants to put its money where its tickets make sense.

(Updates with portfolio diversification in last paragraph.)

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