US LPs & co-investment: Risk appetite

The debut co-investment by Ontario Teachers’ Pension Plan (OTTP) in Asia was a flop. The Canadian pension fund teamed up with Unitas Capital to buy New Zealand Yellow Pages for NZ$2.1 billion (then $1.57 billion) in 2007 only to see it flounder. After attempts to find a buyer were unsuccessful, even at a sharp discount to the entry valuation, and creditors assumed control of the business in 2011.

OTPP is a different creature now to what it was then. A Hong Kong office opened in 2013 to serve as an Asia headquarters for all asset classes, and staff were hired locally or drafted in from Canada. OTPP made no secret of its hunger for co-investment in the region – an appetite reflected in its global exposure. Of the C$175.6 billion ($135 billion) held by OTPP at the end of 2016, C$26.6 billion was in private capital, and nearly three quarters of that was in direct or co-investments. The rest is in fund commitments.

Asia represents a small portion of OTPP’s private equity assets – less than 15% – but the pension fund is set up to participate in co-investments from day one as a joint underwriter, with a view to minimizing the chances of another New Zealand Yellow Pages. Alongside Canada Pension Plan Investment Board (which had C$13.4 billion in Asian PE as of March, having completed five direct deals and five fund investments over the previous 12 months), it is seen as one of the most progressive and influential LPs in the region.

The Canadians’ US counterparts are not so bold in Asia: they are more conservative in their primary commitments and largely non-existent in co-investment. This should come as no surprise, given that – even in their home market – US public pension funds are routinely characterized as largely passive creatures. Interest in co-investment is beginning to turn into substantive action, but for they are still far behind the Canadians, for whom solo deals are now on the agenda in North America.

Asked whether US institutional investors can “become more Canadian,” most local industry participants respond with a firm no. Legal structures, oversight mechanisms and alignment of interest are all seen as sizeable obstacles. Removing them would likely involve some kind of legislative intervention. And then there is compensation. “At a US public pension fund you are paid as a government employee,” says one source. “The Canadians are paid market rates but that is a political challenge for a lot of municipalities. There is a lot of opposition to paying public employees market rates – unless you’re a school football coach.”

Pension funds that actively pursue co-investment tend to do it with third-party support. Oregon Public Employees’ Retirement Fund and Washington State Investment Board, for example, outsource co-investment in its entirety to Fisher Lynch Capital. This is an unusual approach, with most groups retaining a degree of discretion. An advisor will be called upon for assistance in underwriting the proposed deal – hopefully within the GP’s timeframe – and the pension fund makes the final call.

There are some US pension funds that have managed to win support from their trustee boards for private equity programs that are more progressive and they have small but sophisticated teams in place. Launching a full-scale co-investment operation would require an even higher level of stakeholder conviction, underpinned by two key points of understanding. First, not all deals will go as planned. Second, the team can emerge stronger from those difficult experiences.

“If you talk to those guys, they will tell you the best experience they had was the first time they lost money,” says one investment professional. “Everyone around the table was able to say, ‘It’s not a sure thing, we are going to lose money and have a bad deal for external reasons or because we made a bad choice.’  It meant everyone had their grown-up pants on, and it led to them making better decisions next time.”

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• Topics
• North America
• LPs
• Advisory
• USA
• Canada
• Co-investment
• OTPP
• Canada Pension Plan Investment Board (CPPIB)