Q&A: Alaska Permanent Fund Corporation's Yup S. Kim

The Alaska Permanent Fund was established in 1976 as a public trust to preserve and convert the state’s non-renewable oil and mineral wealth into a renewable financial resource for generations of Alaskans. As of November 2018, the sovereign wealth fund had $64 billion in assets under management (AUM), of which $8 billion was invested in private equity and special opportunities.

Q: How active has APFC become as a co-investor? In what circumstances would you go direct (i.e. without a portfolio GP partner)?

A: We continue to invest the majority of our annual allocation through funds. That being said, direct and co-investments have become an important part of our mandate and we spend a material share of our time on our direct pipeline. Since we began the program five years ago, we’ve invested $1.9 billion into 25 operating companies, mostly headquartered in North America or Western Europe. These transactions have generated greater than a 2x net multiple on invested capital. We’ve backed several portfolio companies through multiple rounds of funding and today these interests represent about one-fifth of our portfolio NAV and one-third of our gains since inception. We’ve invested significant time and energy cultivating the right relationships to generate relevant, high-quality deal flow at the top of our funnel, to ensure we're able to be selective and access the risk-reward exposures we'd like to add to the portfolio. We’re currently engaged and in the final stages of a co-investment in China, which would represent our first deal in Asia. While we have the capacity to be the lead term sheet, we would never take a controlling stake given our resource constraints. We've engaged several times in transactions with new GPs wanting to building relationships with us, and unsurprisingly, good outcomes often lead to subsequent fund commitments. Less frequently, we'll engage with a fund-less sponsor on a deal if we have deep conviction in a particular sector or niche.

Q: Do your resources dictate the number of GP relationships you can manage and the size of commitments you make?

A: Absolutely. Building relationships is a two-way street and if you’re overwhelmed with the number of managers in your portfolio, it’s difficult to truly engage, invest and develop a long-term, strategic relationship with your GP. The private equity market, for many asset owners, is evolving beyond a simple buyer and seller's market into one where GPs and LPs can mutually benefit from being strategically indispensable. On the LP front, we're able to add value to GPs by offering relevant feedback to their product development pipeline, being early anchors to adjacent strategies, by offering flexibility in size and security-type in co-underwriting transactions, and by offering introductions to other LPs. On the GP front, the ability to gain access to world-class domain expertise, engage deeply with the deal partners and acquire general market intelligence is essential, especially when managing a portfolio from Juneau.

Q: In 2013, APFC moved from fund-of-fund separately managed accounts (SMAs) to direct allocations to funds. What was behind this decision?

A: First, we wanted to eliminate the second layer of fees. Our SMA managers did a superb job outperforming the median benchmarks on a net basis every year for over 10 years; nevertheless, the fee leakage needed to be plugged. Second, the portfolio was over-diversified. We inherited a legacy PE portfolio of over 150 GPs, over 500 funds and a sub-scale average commitment of $20 million. It's significantly harder to generate substantive alpha without higher-conviction, slightly more concentrated fund, and direct investments. Lastly, the primary capital being deployed was not converting into relationship currency that could be leveraged by APFC as an organization. While great returns will always be a baseline requirement for a commitment, there are now strategic factors that weigh greatly when we consider our long-term partners.

Q: How important is venture capital as part of the overall portfolio?

A: Venture remains an important part of the overall portfolio and our strategy is two-fold. First, we focus on committing dollars to those funds we believe are best positioned to capture the next generation of academy-grade enterprise, consumer and frontier technology companies. Secondly, we leverage the few competitive advantages we have at APFC (long-term orientation, asset scale, and quick decision-making) to directly back innovative companies looking to be true disruptors in their respective industries. We hope to be a preferred investor for companies requiring scaled capital commitments over long periods of time and leveraging APFC’s patient profile has empowered us to access opportunities we believe have asymmetric risk-reward characteristics.

Q: When did APFC first back an Asia-based manager/Asia-focused strategy? What is the nature of the exposure to Asia now?

A: It’s fair to say that we’re underexposed to Asia today – 4% of the PE portfolio is Asia, while Asia has a 25% of our global AUM and global market cap – and many of the original commitments had been made by our legacy SMA managers. We don’t have a set target allocation to Asia but recognize that when thinking long-term, it’ll be challenging to meaningfully outperform without a thoughtful Asia strategy.

Q: People tend to like Asia because of the growth story, but what do you see as the principal challenges in building up a portfolio in the region?

A: Private equity in Asia has made substantial, promising developments across multiple vectors in the past decade but several challenges still exist to building a portfolio in the region. First, valuations remain high and the risk of multiple contraction exists against the backdrop of a slowing macro. PE-backed companies traded several turns of EBITDA higher in Asia than in the US – possibly due to a larger share of deal value coming from high-growth internet and technology sectors – but deals seem to be priced to perfection in many cases with little room for missteps. The recent public market sell-off in Asia may have edged expectations to more normalized levels but management teams and owners continue to leverage the macro growth story to command high prices for their assets. The days of generating significant enterprise value growth solely through macro tailwinds without taking competitor market share, increasing profitability or adding inorganic growth through M&A seem to be numbered. Second, while the pool of high-quality senior management talent continues to grow in the region, it remains less robust when compared to that of the US and perhaps that of Western Europe. The vast majority of post-deal diagnosis by GPs seem to point to high-quality management teams for their deal outperformance while poor management teams are most often attributed to poor investment outcomes. Hiring senior operators with the right backgrounds to execute on very specific PE value creation plans seem to be a challenge. This is exacerbated by the fact that in many cases, companies are still family owned and controlled and gives PE owners less influence over hiring decisions. Lastly, as it pertains to non-China opportunities, given our small team, it is sometimes difficult to justify the time and effort needed to due diligence regions and countries that have had mixed private equity track records.

Q: How much innovation are you seeing in private equity product development? For example, are longer-dated funds the future or do you see other strategic gaps that you would like to fill?

A: We’re seeing substantive PE product innovation emerging from both GPs and LPs who are crafting novel investment structures away from the traditional closed-ended funds to solve critical pain points felt by both parties and it’s been exciting to be early anchors to some of these initiatives. Some examples include investing in investment firms specializing in private markets – both emerging and established – and backing long-term, permanent capital vehicle investors.

Q: What are the attractions of these two strategies?

A: On long-term minority stakes in GPs, the concept of investing in investment managers is not new as financial-services buyout firms and certain public companies have been focused on it for years (though target firms employed mostly public strategies). As active PE LPs, though, we’d hope to leverage our unique insights into the ecosystem to evaluate which established and emerging platforms have the greatest ability to expand vertically (through AUM growth) and horizontally (through adjacent product expansion). Private equity platforms can have great appeal as operating businesses given their ability to scale quickly, be highly cash generative, enjoy recurring fee-based revenues and leverage their domain expertise across product verticals. As for long-term, permanent capital vehicles, in today’s competitive world of private equity, top-decile CEOs and management teams have their pick of partners – many of whom may be exhausted by the constant turning of owners every 3-5 years and the need to re-acclimate to different, nuanced owner-operator dynamics. The idea of being permanent equity owners in companies can be highly compelling to management and you’re able to access a wider toolkit and value-creation initiatives which optimize long-term results beyond the typical five-year ownership period. It’s critical to agree on a fair set of terms around governance and economics, but I believe GPs, LPs, and management teams can all win from an investment vehicle and an approach that is thoughtfully constructed for the long-term.

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• Topics
• North America
• LPs
• Fundraising
• USA
• Alaska Permanent Fund Corporation (APFC)