Against the backdrop of tougher market conditions and its overweight to private equity, $74.4 billion Alaska Permanent Fund Corporation (APFC) will only commit around $1 billion to private equity in 2023, down half what it normally invests in “busier” years. It will mean the investor narrows down the number of funds it backs and writes smaller cheques, chief investment officer Marcus Frampton told trustees in a recent board meeting in Juneau.
Smaller cheques will make it hard to get allocations with some funds, but a smaller allocation will also hold benefits like more influence with fewer relationships. It also means successful and innovative private equity investment shows up more in the portfolio.
The board heard about the risk of elevated valuations in private equity, and a lack of valuation reset relative to public markets, particularly in the venture capital space where companies are avoiding financing rounds or employing “creative financing” to circumvent mark downs.
The only other allocation to also flash red is APFC’s dwindling risk parity, where trustees heard of the investment team’s aversion to accessing the asset class via a leveraged approach given higher interest rates.
reducing PE further
APFC’s private equity portfolio has grown from $1.7 billion in 2012 to about $15.7 billion in 2022 at an annualized rate of 25 per cent. But a significant proportion of value in the portfolio is unrealised gains. Of APFC’s $11 billion in unrealized gains, almost $6.3 billion (57 percent) is from the private equity portfolio. Drilling down further, trustees’ heard that about a sixth, or $1.1 billion, of unrealized gains pertains to investments in funds made more than eight years ago.
Trustees’ heard how the changing dynamics in private equity will test manager skills. With more than a decade of low rates and rising asset multiples, managers on average have become less adept at improving the performance of their portfolio companies as reflected in the declining revenue and margin growth.
“This shift from conventional private equity strategy may prove costly when costs and rates reverse trend and rise,” said board documents.
Writing smaller cheques means APFC may lose its seat on Limited Partner Advisory Committee boards where LP investors in the fund take an oversight role.
“If you’re writing smaller cheques, you’re not offered a LPAC seat,” said Frampton. “But all else being equal, I’d rather the right portfolio exposures ahead of getting a board seat.”
APFC’s private equity fund commitments in quarter ending December 2022 ranged between $8 million to $50 million.
Today’s reduced allocation to private equity is a sign of things to come, and APFC is likely to pare back its allocation to private equity ahead. Existing investment policy targets a 19 per cent allocation to private equity in 2025 (compared to 17 per cent today) but Frampton’s CIO Recommended Asset Allocation suggests a 15 per cent allocation in 2025.
increasing Absolute Return and RE
Reflecting on other portfolio tweaks, Frampton is also seeking to increase diversification with a little less equity and boosted allocations to absolute return and real estate. In real estate, APFC can earn “CPI plus five” without taking on more equity risk, he said.
“Absolute return and real estate are areas where I suggest we increase.”
Success in the $6 billion absolute return portfolio, and its ability to run a low correlation to equities, depends on execution – and increasing the allocation to hedge funds could make execution more challenging. However, although hedge funds may not fit in a typical pension fund portfolio, he argued hedge funds could do better than stocks, and suit APFC.
“If we can execute well, it’s worth having a bigger hedge fund portfolio.”
The absolute return portfolio has returned 6.8 per cent since inception with a volatility of 3.4 per cent.
Frampton said APFC’s public equity allocation is overweight value and small cap.
“I’ve been surprised how strong the market is given inflation and rate hikes,” he said.
The last time equities fell so much without the Fed pivoting to easing was in the inflationary ’70s. One again it makes execution, and timely rebalances, central to strategy, he said.
Reflecting on other allocations, Frampton welcomed a real return in TIPS and corporate bonds for many years. Other adjustments to the portfolio that have worked well include increasing exposure in early October to REITS in “a good trade.”
Frampton described office and retail real estate as “tough” but with good fundamentals and said the pricing “looks good” on industrial apartments.
APFC is on track to commit around $1 billion to infrastructure and private credit this year.
In private credit APFC favours drawdown, private equity style funds in contrast to open ended allocations where the capital is drawn up front and investors are redeemed on a quarterly basis.