A white-hot year for private equity has resulted in exceptional absolute returns for Oregon Public Employee Retirement Fund’s $25 billion private equity portfolio. However, given a more complex relative return picture, and the allocation relative to target remaining stubbornly high, due to outsized mark-ups and gains, the portfolio is not without its frustrations.
“The challenges in terms of the appreciation in the portfolio and the impact on total asset allocation is a universal problem in private equity investors of scale,” said Tom Martin, global head of private equity at advisory firm Askia in a presentation with Michael Langdon, director of private markets at Oregon State Treasury, to council members, guardians of Oregon’s state funds including the $85.5 billion OPERF portfolio.
At the end of last year, the private equity allocation represented roughly 26 per cent of the entire portfolio, at the top end of the fund’s 15-28 per cent target allocation. One-year returns were 41.8 per cent exceeding the fund’s policy benchmark Russell 3000 Index plus 300 basis points, but trailing the benchmark for the asset class, Burgiss All Funds Ex. Real Assets.
Although unprecedented IPO activity drove exit volumes in 2021, council members heard that IPOs don’t necessarily result in meaningful distributions for private equity partnerships. In most cases, liquidity is dripped over time.
“Exits don’t immediately translate into liquidity,” said Martin. “Private equity managers can be reluctant to upload public holdings, it takes time to unwind out of the portfolio.”
The council heard how distributions are largely at the discretion of the GP and asset owner influence is confined to dialogue and advisory board-seats – or choosing not to invest again.
“It depends on where GPs are in the fundraising cycle. Investors are not too keen to support managers that don’t return capital that is readily available to be returned,” he said.
It’s not only difficult for investors to control or time distributions. Asset owners also struggle to control when managers will activate funds, a process that can be pushed into the following year.
“We can’t control when managers will activate funds. It’s impossible to precision engineer a $3 billion number so our range is important. It’s important to try and focus on the things we can control.”
The council heard how for the calendar year 2021, the private equity portfolio processed capital calls totalling $5.5 billion and distributions totalling $7.6 billion for net distributions of $2.1 billion.
Another key focus of strategy has involved ongoing rationalisation of GP relationships in terms of both size and absolute exposures. Although a “long list” of relationships have been cut, OPERF has signed up with a handful of new, sought-after managers.
“Even in a constrained pacing environment, we made room for these relationships,” said Martin. “We now have a core set of relationships that feels good. We might see some opportunistic adds in terms of new names, but on a limited basis and drawn off a long-term wish list.”
Council members heard how strategy centres around consistent and disciplined pacing. Memories of the fund’s uneven pacing before and after the GFC which saw it ramp up commitments before the crisis at a weak time for the asset class and sharply retreat in the private equity boom that followed, are still front of mind. Still, holding the line in today’s active fundraising cycle, when pressure to invest and chase the market abounds, is difficult. Total pacing through the year amounted to $3.6 billion, modestly above the top end of OPERF’s target pacing range of $2.5-3.5 billion.
“Maintaining consistent pacing hasn’t caused us to make sacrifices from a quality perspective,” said Martin. “We haven’t been chasing the market.”
In recent years, Oregon has also developed a successful Secondaries program selling off vintage allocations. However, Langdon flagged that today’s healthy secondaries market could get tougher as the supply and demand dynamic shifts in the medium term.
“We don’t want to be forced into a buyers-market,” he said. “All you are ever doing when you are placing this stuff in the secondary market is pulling forward distributions. And in every trade, at either a premium or discount, there are frictional costs – it’s not free. We have to balance what we give up. If we have a strong feeling that the distributions are coming, the better choice is to wait it out.”
Push into VC
This year Oregon’s private equity team will look at how to get more money to work into VC. The fund has a small (5 per cent on a roll forward basis) allocation to VC shaped around a handful of good relationships, but growth is challenged by accessing the best managers where Langdon explained VC investment skill often rests with single individuals.
“When done right, it’s the best return in the world, but good venture deals are done by good individuals and there are very few of them.” This year the team will study the best, scalable implementation models with the view to pick up another 5 per cent.
“We will spend time on it,” he said.
OPERF’s private equity portfolio is structured around three key aspects. A primary program that consists of 45 strong GP relationships where the average commitment is around $250 million per GP split between style, geography, sector and size. Fee mitigation comes courtesy of a co-investment program, outsourced to Pathway Capital. Co-investment currently represent around 20 per cent of pacing, negotiated and structured around discounts where possible.
A third pillar to strategy is smooth pacing, targeting around $2.5-3.5 billion per annum of new commitments to 10-15 opportunities.
Finally, an enhanced monitoring and liquidity program, also with Pathway, manages legacy investments and relationships, as well as vintage exposures.