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If golf is a game of inches, long-term investing is a game of basis points. Funds like ours have a huge advantage in this game due, in part, to our size. I stole this line from Britt Harris (of Texas Teachers): ‘We’re large, we’re liquid, we’re long-term oriented, and we’re essentially unlevered.’ There are now a number of institutions that can say that—but it’s a small number.
The financial crisis changed where the major pools of capital in the world are. We’re one of them. Since you need those four things if you want to get into certain investments, we use our size to our advantage—namely, we are able to get advantageous fees and terms. Also, it allows us to enter unusual investment structures, such as what people call ‘strategic partnerships.’ It’s a term that’s in vogue now, partly because lots of institutions that were big players in less liquid fields aren’t as liquid as they used to be. If you recall, 2008 forced a lot of very prestigious institutions to become forced sellers of less-liquid assets. Secondary markets were a great place to be a buyer—and an even better place to be a market maker.
This turn toward strategic partnerships is also a result of the fundraising environment for private equity and venture capital firms. At this point, it’s harder for them to raise capital than it’s been for most of the last 20 years. From the standpoint of these industries, strategic partnerships solve a lot of problems. They have fewer partners—more efficient for them—plus some close relationship with sticky money. It’s generally not capital that will go out the door after two poor quarters, like some funds of funds did in Q4 2008. That was like a strong Canadian tide—think Bay of Fundy tides, flowing out.
In reality, though, at the State Board we’ve been thinking about strategic partnerships for 30 years. We developed an affinity for the idea of co-investments in early 1990s. We started doing them and worked with Lexington Partners doing private equity secondaries and co-investments and, with Lexington, helped establish their co-investment partner’s fund. We grew with them over time and saw very good investment results, and so we made an equity investment in them recently. This is a situation where we know them really well—we’re a major investor and continue to be—and felt comfortable. We liked it so much we bought it—like the razor commercial. If you intend to be in for a long time, why wouldn’t you do it? We haven’t, however, done what others mean when they say strategic partnership—just handing over a large amount of cash to be invested at will to large private equity firms. It’s something we’re working on—everyone is pitching this—and we’re considering it, but that’s it at this time.
That said, I think the characteristics that people should look for would come down to alignment of interests. Neither party can prosper without the other doing so simultaneously. You don’t want it fee driven, you don’t want an unintentional risk-exposure increase. What you want is something that allows you to efficiently put capital up alongside your partner. They gain scale by your capital; you gain their expertise and the participation in best-ideas portfolios. Look, in general, because of our size and the benefits that brings, we operate at a ridiculously low overhead. Look at the data—we are among the lowest-cost providers for the services we offer. Look at management fees, salaries—we’re hovering around 30 to 35 basis points for the entire operation. That will be near the bottom for pension funds in North America. This is a result of a good team and board, yes, and some smart decisions, but a lot of the credit goes to the changing market and our size. We’ve just been quick to take advantage of what this brings. As I said, long-term investing is a game of basis points, and we intend to be competitive in this game.