Case Studies: Separate Accounts

The effectiveness of separate accounts has been in question as LPs have taken up the practice, with some value when structured appropriately.

In recent years, questions have been raised about the effectiveness and alignment of interests for separate accounts. Large LPs have structured sizable separate accounts with large publicly listed asset managers, including Texas Teachers’ $3B separate accounts with Apollo and KKR and New Jersey’s $1.5B package of commingled fund commitments and opportunistic separate accounts with Blackstone.

In the case of Texas Teachers’ separate accounts, which were meant to invest in a mix of opportunistic investments and the managers’ commingled fund products, much of the capital has been committed to the commingled fund products at regular economics, with fee breaks only kicking in through special recycling provisions that allow Texas Teachers to reinvest distributions for lower fees. The benefits of such special recycling provisions provide little assistance in mitigating the J curve at the beginning of the investment period—one of the reasons why fee breaks are desired—and only make an impact if recycling is required.

However, separate accounts can provide value to LPs when structured appropriately. Here, we highlight three case studies of PE separate-account programs that appear to do exactly what such programs were set up to do: provide additional resources and expertise to the LP, utilize the deal flow from both the LP and the adviser, and create customized portfolios and economics that the LP would otherwise not be able to have in a commingled structure.

Case Study Summary Snapshot

Case Studies 1 & 2 Overview

The first two case studies involve the State of Wyoming’s recent expansion of its private equity exposure through separate accounts. As background, the State of Wyoming has approximately $16B in its portfolio of permanent funds; recently Wyoming’s State Loan and Investment Board (SLIB) approved investing up to 5 percent of the $11B equities portfolio in unlisted securities. The State of Wyoming has been investing in private equity since 2003 and, until recently, had committed an aggregate of $260M to the asset class. The State of Wyoming is advised by R.V. Kuhns and Associates (RVK) and historically accessed private equity through just two GPs: Cheyenne Capital ($250M commitment from Wyoming) and Colorado-based Access Venture Partners ($10M commitment). The assets managed by the State of Wyoming are distinct from the $6.5B in assets managed by the Wyoming Retirement System.

The State of Wyoming began contemplating diversification of its PE exposure in 2011. While it considered expanding its exposure to PE through funds of funds or direct investment into PE funds, RVK recommended the use of a discretionary separate-account structure for the following reasons:
-Greater portfolio customization and lower fees than investing in fund-of-funds
-Fewer resources (investing and administrative) required than direct fund investing

Later that year, Wyoming sought proposals for one or more new private equity discretionary separate accounts. The specified parameters included managers with at least $2B of AUM, exhibited strong historical performance, and met Wyoming’s minimum qualifications. Nineteen firms responded.

The original recommendation from the state treasurer to SLIB was to select two managers to each manage a $250M separate account. The state received board approval in 2013 to commit $600 million to PE over the next three to five years. Hamilton Lane Advisors (HLA) was awarded a $200M discretionary separate account with the State of Wyoming, as was New York-based Neuberger Berman (NB). The additional $200M will be managed by another firm to be selected by Wyoming and its advisor, with existing GP Cheyenne Capital in the running.

Case Study 3 Overview

The third case study focuses on the evolving separate account relationship between BlackRock and the New Jersey Division of Investment (NJDOI).

BlackRock was founded in 1988, and has grown to manage $4.3 trillion of firmwide AUM. The firm’s private equity fund-of-funds and direct co-investment activities were originally launched in 1999 as part of the Merrill Lynch Investment Managers platform. Subsequently, BlackRock acquired MLIM in October 2006, and the group was renamed BlackRock Private Equity Partners (BPEP). As of Sept. 30, 2013, BPEP had approximately $16.8B of total PE commitments under management, including assets taken on from the acquisition of Swiss Re’s PE and infrastructure funds-of-funds business in 2012. In addition to its funds-of-funds products, BPEP has actively pursued separate-account mandates for large LPs, including the ones with NJDOI.

NJDOI is notable for having aggressively struck separate-account arrangements with several fund-of-funds and direct PE fund managers in recent years, led by Christine Pastore (co-head of alternative investments and head of private equity) and now spearheaded by Timothy Walsh following Pastore’s departure in 2013 to become head of IR at tech-buyout firm Vista Equity Partners. NJDOI’s private equity consultant Strategic Investment Solutions (SIS) is also involved in the due diligence of proposed separate-account commitments.

BPEP’s relationship with the New Jersey plan dates back to 2005, when the first separate account—SONJ Private Opportunities—was formed to pursue PE co-investment opportunities sourced by NJDOI and BPEP. Successor separate accounts SONJ Sidecar and SONJ Private Opportunities II were created in 2007 and 2008, each with $200M of committed capital.

Due to significant changes in the deal environment soon after their creation, SONJ Sidecar and SONJ II’s capital deployment was stunted. In 2011, NJDOI consolidated those two separate accounts into a single vehicle to adjust the strategy and more efficiently manage the large amount of unfunded capital ($310M out of $400M in total commitments) in SONJ II and SONJ Sidecar. The renegotiated terms of the consolidated vehicle provides a useful perspective of how to structure separate accounts for a more mature pool of capital.

A year following the restructuring, NJDOI elected to commit another $400M to SONJ II, in large part to maintain NJDOI’s co-investment capabilities. At the time the decision was made, the existing SONJ II investments had a 14.9 percent net IRR and 1.25x MOIC. The additional $400M of committed capital is structured with even better terms for NJDOI than the restructured terms.

The original and revised terms of SONJ II and SONJ Sidecar are shown in the detailed analysis below: