A look at the practical challenges of meeting target allocations in private markets
Plan Sponsor Exchange - 2020 Conference Coverage
BY Yaelle Gang | March 20, 2020
When it comes to private markets, implementing target allocations is easier said than done.
At the Canadian Investment Review’s Plan Sponsor Exchange conference in February, a panel featuring Julie Cays, chief investment officer at the Colleges of Applied Arts and Technology pension plan; Sean Hewitt, chief executive officer at the Toronto Transit Commission Pension Fund Society; and Daren Smith, president and chief investment officer at the University of Toronto Asset Management Corp., discussed the practical challenges of investing in private markets.
While the CAAT pension plan started investing in private equity in 2008 with a five per cent allocation, Cays said it’s now targeting 15 per cent, with nine per cent currently invested in the asset class.
Meanwhile, the TTC pension plan is aiming for 10 per cent of its assets to be invested in private equity and is currently at just two per cent exposure. “We need to get from the two per cent invested that we have today to 10 per cent,” said Hewitt. “In the meantime, we’re setting interim targets to build that up over time. But that’s going to take a number of years.”
UTAM, which only invests through funds, allocates 10 per cent to private equity, which is in the range of where it wants to be, according to Smith.
Developing key manager relationships
One of the challenges of allocating in private markets is getting into the top private equity funds, Smith said. “Right now, the pendulum has swung so that it’s in the managers’ favour. And a lot of these managers are access constrained. So you’ve got to be actively tracking the best managers and making sure that you’re in front of them, so that when they do open up you’ve got a chance to take a look and potentially invest.”
Over the years, the UTAM has changed its approach to private equity, with the asset class reaching 20 per cent of its portfolio through the global financial crisis. The program was put on pause and re-started around 2015-16.
Pre-2008, the UTAM’s strategy was to diversify and invest with many different managers to take away some of the idiosyncratic risk, Smith said. “But over time, that’s changed and when we re-started the program in 2015 we engaged with a strategic partner. . . . They run a custom mandate for us that’s tailored to our specific program.”
The UTAM has also been building up internal private equity expertise. Today, it has a limit on the number of managers with whom it invests. “We want to have a concentrated portfolio,” said Smith. “We view these managers as long-term partners and we need to be very careful to make sure we partner with the right groups and do the appropriate amount of due diligence.”
For the TTC, access in the private equity space is similarly challenging, noted Hewitt. His team has partnered with a strategic advisor to help the plan access funds. Over the long term, its goal is to move towards internalizing some of that expertise.
At the CAAT, Cays also highlighted challenges, particularly on the private equity side. “The challenge we are having now — given that we’re growing in our denominator in ways that are not easily forecasted and because we’re not at target — is trying to figure out what our pacing model looks like.”
Previously, the plan used smaller general partner funds, but now, with its cheque size growing more quickly as it brings on new plans, the CAAT may not be able to get commitments from existing GPs that are the size they require. “We’re challenged to either go up the GP size spectrum, where all the big guys are playing, or go for more GP relationships. So it’s a tough discussion to be having at the moment.”
Tactics to help reach target
In addition to private equity, the CAAT and the TTC pension plans are looking to reach their target allocations for their infrastructure portfolios.
In 2005, infrastructure was the first private markets asset class deployed to by the CAAT. It started with a five per cent allocation and was combined with real estate in 2016, noted Cays. Today, it’s targeting a 20 per cent allocation for both asset classes and is currently at 14 per cent.
The TTC plan targets an eight per cent allocation to infrastructure. “We’re there on a committed basis,” Hewitt said. “On an invested basis, we’re at about six per cent.”
While there are challenges reaching target allocations in the private markets space, Hewitt noted the TTC plan’s co-investment program has been helpful, particularly in infrastructure.
It’s taken the plan five years to reach its committed infrastructure allocation. “About one-third, 35 per cent, of our invested capital is in co-invest. And that’s helped get some [capital] invested and working for us.”
Cays pointed to open-ended funds, which may involve larger commitments, as one tool the CAAT plan has used for real estate and infrastructure
On the private equity front, she also points to long-term capital structures coming up that may have more space.
Patience is key
In areas like private equity, where the gap between where the TTC plan is and where it wants to be is so wide, Hewitt said he is okay with the plan taking five to seven years to get there. “Getting the right sort of managers and the right sort of vintage year diversification is more important to me than being invested on a timeframe. And we’ve discussed that with the board — that the ability to be patient is a valuable one for a pension and using that kind of patience can hopefully yield better results.”
As well, the TTC plan funds private equity from public equity, so in a way it’s just trading equity risk, which helps as well, he added.
Smith agreed patience is key. “From our perspective, we’re not going to force investments to get to a target. And I think, now — perhaps more than ever on the private equity side — patience makes sense. The best managers only come to market every three or four years and you’ve got to figure out who you want to partner with.
“From our perspective, we’re willing to be a bit slower to get to our desired allocation and all the investments have to make sense.”
From an investment policy perspective, Hewitt also said the TTC plan has a long-term asset mix, but doesn’t base its discount rate on it. Rather, it sets the discount rate based on what it thinks will actually be invested over the next 12 months. “We’re walking towards that long-term goal, recognizing that by the time we get there that’s going to change as well. So it’s a process for sure.”