Wednesday, July 14, 2010

PSPIB in a $1.5B-Plus Secondary-Market Sale?

Laura Kreutzer of the Dow Jones private Equity Analyst reports in the WSJ, Canadian Pension System In $1.5B-Plus Secondary-Market Sale:

Canada's Public Sector Pension Investment Board has put a large portfolio of private equity commitments up for sale, in the latest evidence that a long-awaited boom in deal flow on the secondary market has arrived.

The investment board, manager of pension assets for three national Canadian pension funds including the Royal Canadian Mounted Police pensions, is selling a portfolio estimated to be between $1.5 billion and $2 billion in size, according to people familiar with the deal.

Dallas-based Cogent Partners is intermediary for the deal and expects to receive bids by next week, two people said.

Public Sector Pension Investment Board officials couldn't be reached for comment. "We never comment on market rumors," said Colin McGrady, managing director at Cogent Partners.

The portfolio is heavily concentrated in large buyout funds raised at the peak of the boom, consisting of commitments to less than 10 funds from around a half dozen managers, two people said. That could make for a tough sale, as many secondary buyers don't want to get over-concentrated in the large buyout sector.

That could mean the portfolio is sold in several chunks, rather than in one piece. "I suspect that at the end of the day, they won't get bids for all of it," said one person with knowledge of the deal.

The Ottawa-based pension system, which had C$41.2 billion in assets under management as of Sept. 30, is selling down the interests as it shifts away from investing in funds to doing more direct deals. A year or so ago, James Pittman, who oversaw the investment board's private equity fund program, shifted over to head up direct investing, this person added.

The pension system may also be looking to reduce its exposure to unfunded private equity commitments, which totaled C$4.6 billion as of March 31, 2009, the last time it publicly disclosed the value of its portfolio. That exceeds the fair value of its funded commitments, worth around C$4.2 billion as of that date. Private equity made up 12.4% of the investment board's total assets under management as of that date, ahead of its 10% target allocation.

Public Sector Pension Investment Board launched its private equity program around five years ago, just as the buyout market shifted into high gear. Its poor timing and the youth of its program have had an impact on performance. The private equity portfolio returned a negative 32.3% for fiscal 2009 and a negative 17.9% since inception to March 31, 2009. For the first six months of fiscal 2010, the portfolio did better, generating a 5% return, the investment board said in a mid-year update.

The pending sale offers more evidence that a tsunami of secondary fund deals, predicted by secondary firms ever since the severe economic downturn hit in fall of 2008, has finally arrived.

There have been several $1 billion-plus secondary fund sales this year, including Citigroup Inc.'s just-announced deal to sell a $1.1 billion portfolio of private equity assets to StepStone Group LLC and Lexington Partners Inc., as well as Bank of America Merrill Lynch's earlier $1.9 billion sale of a portfolio of investments to Axa Private Equity.

Lexington Partners, for one, recently put its estimate of 2010 secondary fund deal volume at $20 billion, and expects as much again in 2011.

A few comments on this article. If true, I think they're going to have a tough time selling this large portfolio of private equity funds in the secondary market. They won't suffer a substantial haircut, as if they were selling it a year ago, but it's safe to assume that they'll be unloading this portfolio at a discount (how big is anyone's guess).

So why is the Public Sector Pension Plan Investment Board (PSPIB aka 'PSP' or PSP Investments) selling this private equity portfolio? Part of it is an issue of timing. PSPIB ramped up its PE program literally at the top of the market. This means that on top of dealing with the J-curve, they were overexposed to mega buyout funds at the worst vintage years (click on chart above). Timing is everything, especially in private equity.

I should know, I was at PSP back in 2004 and helped Derek Murphy, First Vice-President, Private Equity, when he was launching that program. Derek knew things were getting overhyped in PE, but he had a mandate to invest in private equity and made several large allocations to top funds. Looking back, it's easy to say PSPIB was overexposed in certain vintage years, but that was the risk of investing in private equity and ramping up at what we now know to be the worst possible time. I'll never forget what Derek once told me: "If you don't want risk, don't invest in PE."

The article also mentions that Jim Pittman shifted over to head up direct investing. I consider Jim to be an outstanding, hard-working professional with the highest integrity. His strength really lies in direct PE investing, and PSP Investments may have decided to unload these fund stakes in the secondary market so they can focus more on direct investments and co-investments.

Why focus more on direct investments and co-investments? Because you can reduce the J-curve by reducing fees, realizing gains on investments much sooner. Of course to do this, you need a strong team in place, people who know what they're doing and who will be able to quickly assess the merits of the deals GPs are presenting to them for co-investment opportunities. That's where Jim and his team come into play.

In my opinion, the timing of this secondary deal is a little premature. I would have waited another year, but maybe they prefer to unload these fund stakes sooner to focus on direct investments. Maybe PSP Investments sees long-term structural issues in the private equity market. This point was also raised to me earlier this week when I spoke with a senior pension officer at the Canada Pension Plan Investment Board.

On this last point, Knowledge @ Wharton had an interesting panel discussion on Wednesday, Private Equity: 'Is the Golden Age Behind Us?' (click here for the PDF file). I quote the following:

With respect to later stage private equity and its dependence on leverage, "The question is whether the golden age is behind us," stated Amit, professor of entrepreneurship and management at Wharton. "Will leverage for buyout return? If so, when and at what pace? What investments will PE firms pursue?" Looking at transaction levels, he pointed to a sharp decline in the number of mergers and acquisitions and IPOs in 2010. Globally, according to a report in The Wall Street Journal, 295 companies raised $42 billion worldwide in the second quarter of 2010, compared with 274 that raised $51.5 billion in the first quarter, an 18% decline in dollar volume. Many companies are continuing to put off IPOs in the hopes that prices will recover.

Overall, it will take longer for returns to come in than they have historically; one private equity participant has suggested that investors are lowering their expectation for returns to where they were five years. A Boston Consulting Group study estimates that up to 40% of private equity firms will close down in the next several years.

Amit added that bankruptcy in the U.S. has gone up dramatically, which brings about further uncertainty in private equity and affects industries ranging from real estate, to automotive to transportation. So what are private equity players doing? One answer is they are moving to emerging economies, Amit said, citing a sharp increase in the percentage of investment in these areas.

There will undoubtedly be a shakeout in the private equity industry over the next several years. The same will happen in real estate and hedge funds. Given the environment, only the very best private equity funds will survive. And the best aren't necessarily the biggest. I would focus more on finding managers with hands on operational experience. They will survive the shakeout. The investment banking/ financial engineering types will close up shop.

Finally, PSP Investments will soon report their FY2010 results. Given that markets rallied during their FY 2010 (March 31st 2009 - March 31st 2010), I suspect PSP's results will be strong. I will take a closer look at the private equity portfolio when the results are made public.

It so happens that today I enjoyed a nice, long lunch with Pierre Malo, my supervisor at PSP Investments and former First Vice-President, Asset Allocation Strategies and Research. Like his mentor, Jean Turmel, who I had the pleasure of sitting down with back in May, Pierre is a true gentleman and someone who takes fiduciary risk very seriously.

We had a long conversation on governance, fiduciary risk, the investment environment, and what needs to be done to better align interests between fund managers and stakeholders. But more importantly, we talked about life and where we are heading.

Pierre and I are both trying to find our 'utility functions'. He recently retired from PSPIB, and is now consulting and looking to sit on boards of pension funds. If you are looking for an experienced investment professional with sound judgment to sit on your board or for consulting mandates, I suggest you contact him at

As for me, my contract with another federal Crown corporation recently ended after almost two years. I continue to blog at night, and swing trade stocks during the day. Pierre told me to look into monetizing my blog and he advised me to "focus on analysis and leave personal attacks out of it because it lowers your credibility with your readers."

I will take his advice to heart. I've been through a lot over the last four years. Sometimes my anger takes over when writing my blog, but I have no regrets whatsoever when it comes to career choices and consider myself lucky to have had the opportunities I've had working in hedge funds, private equity and other asset classes. Very few senior investment analysts have had the opportunities I've had so early in their career.

It's too bad that the people who offered me these opportunities also deeply disappointed me in the end. But that's the past, and no matter how it ended, I will always appreciate the opportunities they gave me.

Now I have to look forward and start thinking about building my life again, hopefully doing something I love with people I respect and can learn from. I thank my former supervisor and friend Pierre Malo for sharing his wisdom and insight on life with me. May we find our utility functions soon and may we be better off for it.

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