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AMERICAS NEWS: Entering the next phase

At this month’s board meeting of the Employees Retirement System (ERS) of Texas, the investment staff will propose Phase II of its emerging manager program. Bob Sessa, director of real estate at ERS, told PERE that, pending board approval, the changes would include a “more robust” program – with increased commitments by ERS over the next five years – in order to “increase our opportunity set and, most importantly, add attractive risk-adjusted returns to the trust.” He could not disclose more information on the changes, but he noted that details will become public following the February 25 meeting.

Currently, the $25.3 billion pension plan has a $50 million commitment to real estate emerging managers through a fund of funds structure managed by Morgan Creek Capital Management and Oak Street Real Estate Capital. For fiscal year 2014, which started in September, the pension has $14 million remaining for commitments to emerging managers. Of the deals closed so far and those set to close soon, Sessa noted that all of them have been through fund structures. “To date it’s just been funds, but we keep an open mind,” he said.

According to Texas legislature, ERS “must make a good faith effort to award contracts to or acquire services from qualified emerging fund managers when acquiring private financial services.” Sessa explained that the state law defines an ‘emerging fund manager’ as one with less than $2 billion under management, but ERS narrows that definition further when it comes to real estate. “It’s a little too broad and would probably cover about 80 percent of the real estate universe,” he said. “We say first, second and third-time funds, usually under $400 million to $500 million.”

Aside from the fact that the state mandates investments in new managers, ERS particularly likes emerging funds as they are good alpha generators, can provide solid risk-adjusted returns, afford portfolio diversification across markets and sectors and allow the pension to discover rising talent. “We like to identify the next up-and-coming managers and be able to get in early with them,” Sessa added.

Of the real estate managers that have gone through its program, ERS has moved on to committing directly to one ‘graduated’ firm thus far—Pennybacker Capital. ERS invested with the Austin-based manager’s second fund in 2012 through the ERS fund of funds program and chose to re-up with a $15 million direct commitment to Pennybacker III at the end of last year.