TRS told innovative partnerships will drive returns

The Texas Teachers Retirement System (TRS) continues to build innovative relationships with its managers, the latest of which has seen it take a $250-million equity stake in asset manager Bridgewater Associates LP.

The decision to invest in Bridgewater comes as its strategic partners in private equity told the TRS board that they were confident the fund could meet its return objectives.

George Roberts, co-founder of Kravis, Kohlbert Roberts (KKR), which manages $3 billion for the fund, told the TRS board that the fund was well positioned to meet its 8 per cent target.

This is a rare bullish position for a US public pension fund. Most board discussions, including the largest fund in the country, CalPERS, have centred on whether funds can achieve their return targets, which for the Californian fund is 7.75 per cent.

“You have a 7 or 8 per cent bogey to meet your obligations and you are in a pretty good position to do that today,” Roberts told the TRS board.

As well as Roberts, Leon Black, co-founder of Apollo Global Management, which also manages $3 billion for TRS, also gave a bullish presentation to the TRS board, saying that distressed European debt and commodities presented attractive risk/reward propositions.

Since joining the fund in 2006 as chief investment officer, Britt Harris has dramatically increased investment in private markets, with private equity now making up about 12 per cent of the $104 billion fund.

In its latest push to develop closer relationships with its managers the board has approved purchasing part of founder Ray Dalio’s stake in the Bridgewater business.

Yesterday TRS released more information about the deal, saying it had been offered the investment opportunity by Bridgewater.

The fund, which previously had a strategic partnership with Bridgewater, was offered the stake in the asset manager at the same terms offered to management and employees buying into the business.

Along with employees, TRS says “a few institutional investors” have also been offered stakes in Bridgewater, but does not disclose who these investors are.

In outlining its reasons for the investment in Bridgewater, TRS says returns will be generated through annual profit and capital appreciation, as well as through growing a client base.

“The value of TRS interest in Bridgewater also has the potential to increase if Bridgewater’s investment performance is able to attract new clients and result in assets under management, thereby increasing profits over time,” the fund says.

“TRS believes this is one of the best investment opportunities of its kind.”

Revolutionary model for private equity investment

The Bridgewater deal follows TRS deciding in November 2011 to expand its strategic partnerships to private markets and invest $3 billion each with Apollo and KKR.

TRS claims these partnerships will give it considerably better terms than the broader market.

Both Black and Roberts described the partnerships as “revolutionary” models for private equity investment.

They said that these strategic funds were a “win/win”, providing virtually permanent capital to the manager, while also garnering a closer relationship for the investor which would result in faster decision making, a closer alignment of interests and better shared information.

Black told the board there was €1.5 trillion of European distressed debt that banks and other financial institutions were looking to shed with $30 to $40 billion of investor funds chasing the best opportunities.

“This gives us the best opportunity to cherry pick the best risk rewards and this is something happening in real time right now and can generate real returns in the twenties from being in the senior part of the capital structure, which is really extraordinary risk reward,” Black told the board.

Roberts stated that now was the time for the fund to “lean in” and get out of treasuries and fixed interest, allocating more to alternatives where the returns could be more attractive.

“In the alternatives space, where you are going to get very good returns for the risk you are taking, you can get 3 to 4 to 500 basis points over a triple B by a riskless energy strategy and you guys are taking advantage of that,” Roberts told the board.

Painfully better terms

TRS has not released the details of its agreements with Apollo or KKR, but Roberts described the terms as “painfully better” than what the funds’ competitors can achieve.

The fund’s chairman David Kelly took the opportunity to talk directly to members at the board meeting in Lubbock, Texas, telling them that such strategic partnerships were only possible because of the scale of defined-benefit plans.

“They [Apollo] have created 30 per cent returns gross, and then net of their compensation, 26 per cent went to the investor,” Kelly told members.

“Our team, which again would not be available in a defined-contribution plan, is going to get part of that 4 per cent back for the benefit of our investors and has done so. So, effectively you will make when fully funded, when everything works, a 26 per cent return or better on that $2200 odd dollars you each gave them to invest.”

Black told TRS that its Fund VII, which represents TRS’ largest commitment to Apollo of $750 million, had generated a net internal rate of return (IRR) of 14.6 per cent so far last year, and when figures were finalised this would be closer to 22 per cent.

In documents provided to the meeting, KKR says that it its overall private equity composite returns since inception in 1977 to September 30, 2011 have outperformed market indices.

KKR says it has achieved a gross IRR of 25.7 per cent and a net IRR of 19 per cent over this period, compared with the S&P 500 that generated 10.9 per cent and Russell 3000, which returned 10.6 per cent.

Since the arrival of CIO Harris, the fund has overhauled its investments strategy, slashing allocations to equities and increasing investments in real assets and alternatives.

During 2007, the board adopted a proposed allocation that saw US equities fall from 46.9 per cent of the portfolio to 20 per cent and private equity increase from 4.1 per cent of to 12 per cent.

TRS has achieved a 4.56 per cent return over the past three years to September 30, 2011 and 2.63 per cent over the past five years. This, according to its consultants Hewitt Ennis Knupp, puts it at or near the top quartile of peer funds over this period.