Supersized private equity allocations at CDP and CPPIB?

It has been awhile since independent film maker Morgan Spurlock released “Super Size Me”. My mind is drawn to that movie when I think about the quantum of money that Canada’s two largest pension funds, Caisse de Depot and CPP Investment Board, have committed to the buyout segments of private equity. Time will tell if the health of these two funds suffer the same outcome as Mr. Spurlock’s did after 30 days of a McDonald’s diet. According to Mr. Spurlock and his 5 medical advisors, his weight increased by 13%, and he experienced mood swings, sexual dysfunction, and liver damage. To date, we are fortunate that CDP and CPPIB aren’t showing any similar signs of ill effect.

Here are some back of the envelope calcs about the current private equity commitments at CPPIB. According to their website, CPPIB has commited about $29.8 billion to direct private equity funds (inc. a very small portion to venture capital). “Paid in Capital” was $14.1 billion at last report (12% of AUM), which means that CPPIB is legally on the hook for an additional $15.7 billion (another 13.4% of AUM).

Using the last quarter’s $117.4 billion CPPIB asset figure, 25.3% (difference due to rounding) of their current assets under management are allocated to the private equity category. Obviously, they are banking on either i) some of these commitments never being called, ii) some of these commitments to be funded by income from other PE funds, iii) the public market baskets to return to prior levels to decrease the apparent concentration in PE, iv) more cash coming from Ottawa to increase the denominator, which would also increase the relative apparent allocation to PE.

Over at CDP, the figures are not easily accessible in any detail. According to their website, the private equity portfolio was $17.7 billion as at 12/07 (15.1% of the rumoured $117B AUM of today). Word is that there are an additional $7 billion of uncalled commitments as of today, which puts CDP’s PE nut at $24.7 billion against rumoured 2008 AUM of $117 billion for a 21.1% concentration.

The question is, of course, is there any truth to the rumour that a further $28 billion is dedicated to private equity co-investments and co-investment commitments. It seems hard to believe that PE co-investments wouldn’t be counted as “private equity” (and therefore be a subset of the ~$24.7B), but if that number is even close and not counted elsewhere, then 45% of their AUM is allocated to private equity. Add in ABCP and you’ve got yourself one illiquid portfolio. Even if the conservative 15.1% figure is accurate, CDP is deeper into illiquid PE funds than most other pension funds, and then there’s the tricky contractual capital calls to satisfy.

How would these figures (if the CDP’s can be confirmed) compare to other world leaders? CalPERS, for example, had US$24 billion advanced to “alternatives”, representing 13.7% of their US$175.7 billion under management (as at February 6/09). The long term asset allocation target for the asset class is 10%. CalPERS describes their “total exposure” to the asset class to be US$50.8 billion (28.9% of AUM), which means their “yet-to-be funded commitments” equal $26.8 billion (15.3% of the AUM). Given the age of the CalPERS alternatives portfolio, the vintage years will likely be, on average, older than those of CPPIB — but may mirror those of the CDP. Older vintage years may be less likely to be fully called than ones which were made in 2006 or 2007 (think Mega Buyout).

Over at Harvard, private equity makes up 12% of their General Investment Account’s US$43 billion of AUM (6/08 annual report). One can’t determine what their uncalled commitments are, but the 12% called portion ties in nicely with those of CPPIB and CDP.

Yale’s US$22.5B endowment had a PE allocation of 18.7% as of June 2007, and the target allocation at the time was 19%. To them, this allocation is smart:

“Over the past two decades, Yale reduced dramatically the Endowment’s dependence on domestic marketable securities by reallocating assets to nontraditional asset classes. In 1987, nearly 80 percent of the Endowment was committed to U.S. stocks, bonds, and cash. Today, target allocations call for 15 percent in domestic marketable securities, while the diversifying assets of foreign equity, private equity, absolute return strategies, and real assets dominate the Endowment, representing 85 percent of the target portfolio.

The heavy allocation to nontraditional asset classes stems from their return potential and diversifying power. Today’s actual and target portfolios have significantly higher expected returns and lower volatility than the 1987 portfolio. Alternative assets, by their very nature, tend to be less efficiently priced than traditional marketable securities, providing an opportunity to exploit market inefficiencies through active management.

The Endowment’s long time horizon is well suited to exploiting illiquid, less efficient markets such as venture capital, leveraged buyouts, oil and gas, timber, and real estate.”

Where does that leave Canada’s two mega funds? Are they really over-allocated to private equity, and if so, what does that mean for every private equity fund that tries to raise new capital in 2009 or 2010? Yale’s weighting is certainly industry-leading compared to a 7% PE allocation benchmark for U.S. education institutions. According to the Harvard and CalPERS figures, CDP and CPPIB are now in the strike zone (although one cannot account for the impact of vintage years), which might imply not many new commitments for the time being.

Managing the cash needs of these new commitments will be fascinating to watch over the next 18 months as the 2006 and 07-vintage Mega funds start to deploy their capital in earnest. The fact that they have modest pre-2004 commitments means that one can’t rely on maturing fund commitments to finance the 2006-07 commitments over the next two years.

Those funds will need to come from cash on hand or through the sale of more liquid assets. And that may not be a welcome prospect if the recession continues and keeps a lid on the public market portfolios.

Where will that $23+ billion come from over the next few years to make good on CDP and CPPIB’s uncalled private equity commitments?

MRM