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Tennessee finally enters private equity game

The $28 billion Tennessee Consolidated Retirement System is a late entrant into private equity with its debut $25 million allocation to the Draper Fisher Jurvetson Fund X, occurring at the same time the fund has cut its allocation to short term assets by 5 per cent.

This is the first time the fund has moved into the private equity asset class according to chief investment officer Michael Brakebill, who also said the fund intended to increase its real estate allocations, broaden fixed-income management capabilities, and explore credit market opportunities and securities lending.

The fund now has about 3 per cent in short term assets, 4 per cent in real estate, 7 per cent in inflation, 3 per cent in international fixed income, 36 per cent in US fixed income, 14 per cent in international equities, and 32 per cent in US equity.

The fund’s private equity director, Lamar Villere, said the DFJ’s investment strategy is mainly “early stage venture capital with a diversified industry focus”.

One of the reasons for the allocation was DFJ’s “unique feature of [the] affiliate network to source potential investment opportunities in various sectors and geographies”.

Villere said the due diligence process included two site visits, a review of the investment process, a review of past fund performance, and reference checks with existing investors and former management teams.

He said there were four reasons for the size of the commitment: it was a planned percentage of the system’s assets to be invested in private equity, and second the timeline to achieve that goal. Third, the number of deals per year for which staff would have the capacity to do adequate due diligence, and fourth, the relative weight of different private equity strategies in the model portfolio.

“Despite the high level of existing portfolio investments that DFJ is managing because of poor markets in which to execute exit strategies, DFJ has sufficient staff to manage additional investments in the fund in which TCRS would invest,” Villere said.

In the large cap sector fund, Roy Wellington said the portfolio maintained its positioning of an expected economic recovery “except that the consumer is judged to be AWOL for this cycle”.

Equity markets continued to rally as confidence in owning risky assets increased, with most of the apparent new economic activity coming from the US government’s economic stimulus program, Wellington says. “CEOs have been so aggressive in cutting costs via layoffs and inventory liquidation that profits are returning well in advance of increases in production.”

Stock prices continued their six-month-long rally into September, defying many investors’ expectations for a pullback, says mid-cap fund spokesman Mike Keeler, and instead posting the 10th best quarterly return of all time as measured by the Russell 2000.

Late in the quarter, retail sales and industrial production supported stock prices, and investors responded by narrowing risk spreads and bidding up prices on 93 per cent of all stock. “This strong breadth made adding value on any factor other than beta very difficult,” Keeler says.

Despite very strong absolute returns, the fund lagged the benchmark in the period, according to Keeler. This was due to factors typically associated with high beta [such as low RoE, low or no div stocks, low dollar price names and non-earners] leading the market, and “unfortunately none of those factors are highly represented in the TCRS’s Mid Cap Fund holdings”.

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