LP interview: PERA New Mexico

It was as recently as 2006 that the Public Employees Retirement Association of New Mexico (PERA) started making commitments to global private equity funds, with a 7% allocation to the asset class. At the nadir of global financial crisis, the pension fund had committed about $600 million, of which only $170 million was drawn.

As a result, PERA's portfolio was not weighed down by restructuring cases. Indeed, its private equity program turned out to be well positioned to take advantage of the buyout market in the aftermath of the crisis. As of March, the asset class was one of the pension's best performers with a 14.1% net return since inception, helping drive overall assets to $14 billion.

Nevertheless, the LP - which administers pension and other benefits for about 100,000 public employees - has adjusted its PE program in response to changing market dynamics. PERA has trimmed its investment silos to four: global equities, risk reduction and mitigation, credit, and real assets. Private equity is part of global equities, which has a 43.5% allocation; the goal to evaluate PE more effectively against other types of equity - long-only, low volatility and hedged.

At the same time, the deployment target for private equity has increased to 8.7%, although not with a view to backing local managers. While the US target has stayed flat, the allocation for international, non-US managers has risen by about half a percentage point.

"We think the US private equity market is too efficient. There are too many GPs and LPs, so we are trying to find different betas in the less efficient private equity markets. Our view is there are more emerging opportunity outside the US," says CIO Jonathan Grabel, who joined PERA in 2014 after a more than 10-year career in the private equity industry.

Dual strategy

PERA has a two-pronged strategy for the asset class: a core portfolio that features many of the larger managers with individual check sizes of $75-100 million, and a more niche exposure to capacity-constrained strategies.

Grabel is part of a 10-person investment group but the LP has limited internal resources to devote to private equity coverage. While some of the heavy-lifting in terms of developing the GP network is done by Cliffwater, a US-based investment consultancy, emerging markets coverage comes through a separate account with PineBridge Investments, targeting GPs in Asia and Latin America.

Track record is not the sole consideration when backing a manager - PERA sees this as too opportunistic - and efforts are made to take a top-down approach to selection based on geography, sector and corporate maturity. "We are trying to disaggregate the GPs in our portfolio," Grabel explains. "For example, if we are underweight healthcare in Southeast Asia, we look for a GP with a higher concentration in that sector and market."

Over the past five years, the LP has added Asian exposure to its core portfolio through three GP relationships: TPG Capital fifth pan-regional fund, which closed in 2007; Warburg Pincus' latest flagship global vehicle, which is active in the region; and, most recently, RRJ Capital, with a $75 million commitment to the firm's third fund that closed at $4.5 billion towards the end of last year.

Grabel cites RRJ as a prime example of the kind of firm PERA wants in the core portfolio. "We look for firms with established local relationships. A franchise or affiliate of a major US PE firm may not be the right structure. It is hard to develop local expertise from a textbook," he says.

Of the $600 million earmarked for global private equity this year, about 10% will be channeled into emerging markets managers via the PrineBridge separate account. Asia-based GPs can expect to receive one third to half of that capital; there is a preference for managers specializing in information technology, healthcare and consumer.

The shift towards emerging markets is not only about targeting relative inefficiency. A growing number of US-based private equity firms - including most of the global players - are pursuing multi-asset strategies and this has raised questions across the industry about alignment of interest: Is diversification driving fee income but at the expense of performance? PERA, for its part, likes managers with a singular focus.

"All the things being equal," Grabel says. "One could argue that some of these multi-asset, multi-strategy, multi-geography US private equity firms are too diversified for the returns of any individual strategy or fund to be of primary importance."

The LP is also uncomfortable with managers that adopt a "take it or leave it" approach to terms and make little or no attempt to accommodate the needs of investors. In these situations - for example, where PERA is only given a $25 million allocation to a fund despite asking to commit more - there is a willingness to walk away from opportunities that was not present before.

"I think LPs often complain too much about terms, fees, and so on. No one is forcing an LP to invest in any given fund. You can simply say ‘no, thank you' and find different managers to work with. You don't have to say ‘yes' just because a GP has a great brand name," Grabel observes.

Cautious on co-invest

As for co-investing in deals alongside GPs, PERA's current view is that it would make the portfolio overly concentrated and potentially more volatile. LPs with substantial human resources devoted to private equity can take steps to mitigate this risk, but for the average US public pension plan, the model does not appear sustainable.

The past 10 years have been characterized by a rising tide of co-investment dollars, and the blip immediately after the global financial crisis notwithstanding, Grabel's view is that private equity hasn't seen much of a downturn. This makes him cautious about the future.

"Co-investment may look prescient in an up market, but markets tend to go in cycles," he notes. "The marginal co-investor may re-think his or her program when markets turn and they are confronted with non-performing, illiquid investments. We need a full cycle to better calibrate co-investment programs."

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• Topics
• North America
• LPs
• Fundraising
• USA
• Public Employees Retirement Association of New Mexico