NEW YORK, March 7 (Reuters-BUYOUTS) - They were supposed to be the New New Thing in private equity. But separate accounts set up to manage money for giant pensions haven’t proliferated beyond a handful of big buyout firms. And a surprising amount of money has been steered into commingled funds on much the same terms that other big investors get.
It wasn’t that long ago that giant separate accounts were going to revolutionize the relationships between the nation’s largest pension funds, with billions to invest, and the giant —mostly publicly listed — private-equity firms that have been transforming themselves into diversified asset managers.
In late 2011, the $112 billion Texas Teachers’ Retirement System announced two $3 billion separate account partnerships, one with KKR & Co LP (KKR.N) and the other with Apollo Global Management LLC (APO.N). The idea was to leverage the pension’s huge piles of cash to extract favorable fees and terms and — it was strongly emphasized at the time — unique investment opportunities.
“The goal <of these relationships> is to be dynamic and capture opportunities in the marketplace,” said Richard Hall, the managing director for private equity at Texas Teachers’ in an interview in early 2012. “A lot of opportunities ... occur for brief windows of time. So you’ve got to be willing to take some uncertainty in these partnerships, so they can invest in something that’s a little bit different, a little bit off the run, and hopefully by doing that, create profits and excess returns.”
These deals also represented a new style of relationship between private-equity firms and investors, one that was deeper and more collaborative. “The real prize,” said Rusty Guinn, the director of Texas Teachers’ Strategic Partnership Group, “is developing the kind of trust with our partners that allows us to have truly candid conversations about investment opportunities.”
But in the year and a half since Texas Teachers’ and KKR signed their partnership papers, most of the commitments the pension has made to KKR and Apollo have gone to commingled funds, such as the flagship KKR North American Fund XI LP, a fund available to other KKR investors. Of the $3 billion already committed from the two separate accounts, only $400 million (13 percent) has so far been pledged to special situations or opportunistic vehicles.
Hall, speaking last month at the SuperReturn private equity conference in Berlin, said that the majority of the pension’s $2.1 billion in commitments from its separate account with KKR went to commingled funds. A much smaller portion of Apollo’s pledges were made to such funds. All told, Texas Teachers’ has committed $2.1 billion to six KKR vehicles. That still leaves $900 million left to be committed before 2015. For Apollo, $850 million has been committed across six funds, which still leave $2.2 billion left to be committed before 2016.
Guinn said the early focus on commingled funds was due mainly to the time-consuming work involved in creating the structures for opportunistic vehicles. In other words, opportunistic investment vehicles took time to launch, but the structures for commingled vehicles were already in place, so those investments were made first.
One big upshot: Despite the big dollars being put to work, Texas Teachers’ hasn’t seemed to have gained much advantage on fees. For the commingled private equity funds, “we get the same economics that other LPs get,” Brad Thawley, a private equity investment manager for the pension, told an audience in February at the SuperInvestor conference in San Francisco. “The only advantage that we have,” said Thawley, “is that once distributions are made, there is a slightly different carry structure where distributions on the back end flow into a separate vehicle that has different economics.” Those recycling provisions allow for up to half of all distributions to be plowed into another vehicle at a discounted rate.
Meantime, initial predictions that these giant separate accounts would become the industry standard have not panned out. While a couple of other big separate account deals have been launched, including a $1.8 billion account between the New Jersey Division of Investment and Blackstone Group LP (BX.N), and a $500 million account between Blackstone Group and the California Public Employees’ Retirement System, most of these deals have been few and smaller in scale.
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