A number of US institutional investors are finding ways to speed up the process by which they make commitments to private equity real estate firms. The question is whether the benefits of doing so outweigh the risks.
Last month, for example, the Nebraska Investment Council approved a provision in which its investment staff can re-commit to certain follow-up investment funds without board approval. Such freedom is not without restrictions, including limits on commitment size and other parameters. Still, the provision does remove some oversight.
In another example, the New York State Teachers’ Retirement System has relied on the judgement of its executive director to enter into certain time-sensitive investments. Again, there limits on the dollar amount of such investments, as well as other parameters, but a layer of diligence is nonetheless lost.
Most recently, the Los Angeles County Employees Retirement Association (LACERA) revised the traditional definition of a ‘commingled’ fund to speed up its investment process. Wishing to have the benefits of a separate account without going through a lengthy manager search process, as required by its policies, LACERA worked with an existing manager to find a creative solution.
So, just how important is this need for speed? Is it worth side-stepping or amending existing policy and procedure?
True, getting capital out there quickly can enable an LP to take advantage of time-sensitive opportunities, be it a fee break for early investors in a new fund or entering a vehicle with an imminent close. And yes, the earlier an investor’s capital is put to work the better.
Despite these immediate advantages, when all is said and done, it may be better for LPs to remain thorough with their due diligence, even if that process is slow. Indeed, there are still many traps with relying on staff to make the call when it comes to expediting the process of committing to a fund, even if said commitment is small.
Many LPs that PERE has spoken with have expressed concern that surrendering board oversight in any capacity can lead to a dangerous precedent. The biggest danger of pension plans giving their investment staff independence from the board is that it could lead to ‘rubberstamping’, or leading LPs to essentially be on auto-pilot with no oversight when making commitments. In terms of re-upping with a follow-up fund, there could be several disparate factors (changes in management, changes in economy) that could make consecutive vehicles by the same manager worlds apart despite appearing on the surface to have the same strategy.
Although there appears to be many strong opportunities in the real estate sector these days, the need for due diligence now is more important than ever. With capital scarce and LPs paring back the number of managers they’re doing business with, it’s shouldn’t be a given that a pension plan will commit to a follow-up fund.
Even the California State Teachers’ Retirement System (CalSTRS), which re-upped with five managers to the tune of $1.2 billion last month, is against such a policy. CalSTRS does not distinguish between re-upping and making fresh commitments when it comes to undertaking its due diligence. For the California pension, each type is subject to the same scrutiny, no matter how many times it has invested with a particular GP.
Still, it makes sense for there to be a more streamlined system for LPs to take advantage of time-sensitive opportunities and get their capital out there working faster. And although it’s now more crucial than ever for investors to adhere to guidelines, there are some ways to achieve a speedy commitment process without compromising due diligence.
For example, one consultant PERE recently spoke with pointed to the Teachers Retirement System (TRS) of Texas and its ‘premier list’ of managers as an example. Established in 2007, the premier list offers a ranking of the top performing private equity and real asset managers. While managers on the list have a better chance of receiving a streamlined commitment from TRS, the $110 billion pension system conducts due diligence on every fund in which it invests. Furthermore, managers must compete for a place on the list, which is re-evaluated every six months.
In addition, LACERA’s recent $100 million commitment to CityView Bay Area II represents a creative interpretation of what a commingled fund is. Although the CityView vehicle appears to be more of a separate account, if LACERA had made this commitment as a separate account, it would have had to go through a time-consuming request for proposal process. Instead, the pension plan committed to becoming the sole LP in the fund, gaining many of the benefits of a separate account but without the lengthy RFP procedure.
LP boards seeking to balance the need for thorough due diligence with a more efficient investment process would be wise to consider the creative examples set by TRS or LACERA.
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