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

Via Pension Pulse.

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 to 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 the 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 [e-mail].

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.

Comments

[exportbank]

Like ALL pension funds - they follow the herd without understanding that they are but lemmings being herded towards the cliff. Pension funds are suckers just like the small retail gambler. It's funny that some retail "investor's" are still convinced they stand a chance against the HFT machine.

[peaceful]

Hey Leo,

What advice would you give the O-Team on this side of the border in regards to their unfunded pensions?

Hiring contract killers to get after the retirees? This will knock off 2 birds with one stone. You get the Unemployment numbers down while at the same time you take care of some your unfunded liabilities. We can call these new hires a code name like the BUDGET BALANCERS and spin them off on cable as a new Reality series.

[SnarkAttack]

Not sure you name dropped enough there.  Looking for a new pension job?

[Leo Kolivakis]

I prefer the buy side to sell side, but that's not the purpose of my post. I am not sure what I want to do next. What I realize more than ever, it's important to work with good, intelligent people you can trust. Life is too short to deal with ultra egos looking to backstab you.