In a co-investment, you are analyzing the fundamentals of the business. This is different from a fund, where you are looking at the track record of the GP and the quality of the team that is making the investments

Darren Foreman

Senior Portfolio Manager – Private Markets & Co-Investments, Public School Employees' Retirement System

This Special Interview conducted David Grana, Clear Path Analysis' Head of Production, with Darren Foreman, explores the emerging opportunities for pension plans, insurers and other institutional asset owners from co-investing in private market securities alongside fellow investors, both asset owners and third-party investment managers.

David Grana: Why has interest in private market investments grown over the past few years?

Darren Foreman: In the current, low interest rate environment that we have around the world, investors are looking for higher returns. Certainly, one of the asset classes that investors turn to is private markets. This includes private equity, buy-out funds, growth capital funds, venture capital funds, and special situations funds.

David: Have you seen a slowdown in the IPO market during this increased interest in private markets?

Darren: I have heard through our general partners and managers that the IPO market isn’t quite as robust as it has been in the past 12-18 months, but I do feel that this will comeback. A lot of these global private equity firms in the mega-cap space of $1 billion plus enterprises are going to have to turn to the public markets for their exits. They could, of course, sell to a strategic corporate fund or a corporation, but the IPO market will see demand even though it seems to have cooled at the moment.

David: Within the private equity space, what are some of the main differences between private equity co-investments and fund investments?

Darren: There are differences in due diligence, timing, risk, and fees. For timing, if you are assessing whether or not to commit to a private equity fund, you have weeks or months to make this decision before there is a final close. Whereas, in a co-investment, it could be just a matter of a few days before you have to let the general partner (GP) know whether you are interested or not. In a co-investment, you are analyzing the fundamentals of the business. This is different from a fund, where you are looking at the track record of the GP and the quality of the team that is making the investments. With risk, if you are going to make a co-investment, it is only one investment, whereas, when you invest in a fund, it could be a portfolio of 8-40 investments. The co-investment comes with more risk. In terms of fees, you may pay 1.3% on commitments to 2% or more per year investing in a fund, plus 20% profit share or carry. However, in co-investments, they are generally free of a management fee and carry.

For PSERS, we like a mix of both. We only co-invest with GPs who are currently in the portfolio, but we like to see the co-investments comprise about 10% of our net asset value (NAV). At some point going forward, and at the moment, we are a little over 7%. We would like to scale up the program in the future to get about 10% of our program.

David: What are some of the general criteria that separates favorable co-investment deal from an unfavourable one?

Darren: The way that our governance is structured for the co-invest program is that we can only co-invest in a fund where we also act as an LP. In other words, it has to be a current manager. This is helpful, since we rely on the due diligence of that GP that we have invested in. We look at whether the co-investment is in the GP “sweet spot”. We also look at whether the GP is in control of the investment. We ask if it is a repeat company or industry where the co-investment is offered. If they have had experience in that particular industry, it can be very helpful. From a co-investor standpoint, we want to ensure that they understand the investment thesis, because for us, if we don’t understand it, then we can’t talk to our internal member investment committee and feel good about recommending it as an investment.

David: How competitive is the co-investment market?

Darren: As you can imagine, if you can invest in a co-investment with no fee or carry, it is very competitive. One of the factors that helps us out is that we have invested in private markets over the past 33 years and have built great relationships with our GPs. It is very critical to do so, because you need good lines of communication and mutual respect for one another in order to see good deals flow from your investments.

David: What impact do you think the increased activity in private markets will have on public market securities?

Darren: There has been a lot of capital raised by private market funds, and funds in the large and mega-cap space are going to have to put that money to work and invest it. You will see public to private equity transactions take place in the future at an increased rate.

If you are a public company, you have to worry about quarterly earnings reports, whereas in private equity, we have a 3-5 year goal to make sure that you hit the investment objectives. This appeals to a lot of senior management in the public company universe.

David: Do regulations differ greatly between private and public companies?

Darren: You have a certain level of regulation, even as a private company, but the time horizon for expectations on hitting your goals is years for private firms, but quarterly for public companies. This makes a big difference. In public markets, you have to meet the earnings per share by a penny to make the Wall Street community happy so that your stock doesn’t decline. This can mean that some public companies may decide to go private in order to enjoy that longer time horizon.

David: Would you say that co-investments have been successful in achieving the private market portfolio’s goals?

Darren: These investments provide a very good opportunity to average down the costs in private markets. When you invest in co-investments, there are generally no fees and carry. For us, it has been very successful. We started our program in February of 2012 and have done 37 co-investments to date, with 3 of them having been realized. Since June 2017, we have 31.5% net IRR and our inception multiple, which is the total value of paid-in multiple, is 1.75x. It has been very rewarding for us. From February 2012 onward, we have also saved in fees. Rather than paying a 1% fee for a third-party manager to manage co-investments on our behalf, we have saved $17 million.

David: Presumably, the teachers of the state of Pennsylvania are very happy about that.

Darren: I hope so. We are working hard on their behalf.

David: Thank you for sharing your views on this subject.

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