Ohio Public Employees Retirement System

Transcription

1 Ohio Public Employees Retirement System Private Equity Policy DRAFT - August 2005

2 TABLE OF CONTENTS I. SCOPE... 1 II. PURPOSE... 1 III. INVESTMENT PHILOSOPHY... 1 IV. ALLOCATION... 1 A. CORPORATE FINANCE... 1 B. VENTURE CAPITAL... 2 C. SPECIAL SITUATIONS... 2 V. INVESTABLE INSTRUMENTS AND RESTRICTED INVESTMENTS... 2 A. INVESTMENT TYPES... 2 B. CO-INVESTMENT AND DIRECT PLACEMENTS... 2 C. HEDGE FUNDS... 2 D. DERIVATIVES... 2 E. REAL ESTATE... 2 F. OHIO AND REGIONAL... 2 G. STOCK DISTRIBUTIONS... 3 H. CHILD LABOR... 3 I. PRIVATIZATION... 3 VI. PERFORMANCE OBJECTIVES... 3 VII. RISK MANAGEMENT... 3 A. LIQUIDITY... 3 B. VINTAGE RISK... 4 C. MANAGER RISK... 4 D. FIRM RISK... 4 E. CURRENCY... 4 F. INDUSTRY... 4 G. GEOGRAPHY... 4 H. LEVERAGE... 5 VIII. ROLES AND RESPONSIBILITIES... 5 A. BOARD OF TRUSTEES... 5 B. INVESTMENT STAFF... 5 C. INVESTMENT ADVISOR(S)... 5 IX. MONITORING AND REPORTING... 5 A. QUARTERLY... 5 B. ANNUAL... 5 Revision History Policy Established September 2002 Policy Revised June 2003 Policy Revised November 2004 Policy Revised -DRAFT August 2005

3 I. SCOPE This policy applies to the Private Equity assets within the Ohio Public Employees Retirement System ( OPERS ) Defined Benefit Fund. II. III. IV. PURPOSE This policy provides the broad strategic framework for managing the Private Equity assets. INVESTMENT PHILOSOPHY The Private Equity program exclusively uses active management strategies and is 100% externally managed. The OPERS Annual Investment Plan establishes the short and longterm approaches for achieving the performance objectives consistent with the requirements of this policy. ALLOCATION Asset allocation is a critical driver for the long-term success of the private equity program. Standard portfolio theory suggests that we control asset allocation risk by establishing class and subclass target portfolio exposure parameters and optimizing the portfolio along risk and return. Private equity is not conducive to a rigorous quantitative approach and asset allocation risk is controlled through long-term subjective market value class and sub-class parameters. Long-term class and subclass market value targets are established below. Each class and sub-class is bounded by ± 5%. A. Corporate Finance Domestic International Total Corporate Finance Large 30.0% 12.5% 42.5% Mid/Small 20.0% 7.5% 27.5% Total 50.0% 20.0% 70.0% Venture Capital 15.0% 0.0% 15.0% Special Situations 10.0% 5.0% 15.0% Total 75.0% 25.0% 100.0% Expected Return 15-25%, Moderate Risk This category is commonly referred to as leveraged buy-outs, but more properly identified as corporate finance. Capital is typically invested in more established companies, those further along the business life cycle having relatively predictable cash flows and the ability to raise capital along the entire capital structure, including secured and unsecured debt. 1

4 B. Venture Capital Expected Return 20-30%, High Risk Venture capital equity is targeted at companies in the earliest phases of a business lifecycle. Companies may be classified as seed, early, middle and late stage and are characterized by their inability to access public equity and other forms of capital such as secured and unsecured debt. These companies have uncertain revenues and a need for cash to build their businesses and are subject to high failure rates. C. Special Situations Expected Return 15-25%, Moderate Risk Many private equity opportunities have characteristics of corporate finance or venture capital but have enough differences as to require separate classification. These investments include distressed debt, mezzanine, opportunity and secondary funds. V. INVESTABLE INSTRUMENTS AND RESTRICTED INVESTMENTS A. Investment Types This policy authorizes commitments to private equity partnerships and discretionary managers investing in private equity partnerships. These partnerships may invest in any type of security throughout the capital structure. B. Co-investment and Direct Placements Limited partner rights may include opportunities for additional capital participation such as co-investment or other side-by-side direct investment opportunities. While staff may develop capabilities to participate and manage these opportunities, committing capital for exercising these rights is currently prohibited. Discretionary fund of fund managers may exercise limited co-investment rights. C. Hedge Funds Hedge funds are not within the scope of this policy and are prohibited within the private equity program. D. Derivatives Investing in partnerships that purchase options, futures, swaps or derivative securities for speculation is prohibited. E. Real Estate Real estate is not within the scope of this policy and investments in partnerships targeted primarily to equity and/or debt of real estate is prohibited. F. Ohio and Regional OPERS is supportive of economic growth in Ohio and encourages relationships with Ohio based private equity firms. Opportunities are evaluated on their merit, including 2

5 risk adjusted return expectations and consistency with the Annual Investment Plan. All else equal, preference will be given to Ohio based firms and/or firms investing in Ohio or the Midwest region with a goal of 3-5% of the portfolio composition. G. Stock Distributions Listed stock distributions will be liquidated within ninety days of receipt and removal of all trading restrictions. Unlisted stock distributions will be liquidated in an orderly manner. H. Child Labor Investing in partnerships that seek to benefit from exploiting child labor is prohibited. I. Privatization OPERS does not aim to promote privatization of public sector jobs through its private equity investment program. It is highly unlikely that OPERS private equity investments would be in partnerships that are dependent on privatization strategies. In evaluating private equity partnerships, the staff shall use its best efforts to limit circumstances where privatization may have an adverse actuarial impact on OPERS. If such limitation is not possible, the staff shall seek guidance from the Investment Committee prior to committing to such a partnership. VI. PERFORMANCE OBJECTIVES OPERS Private equity performance is benchmarked on a long-term, 7-10 year, rolling basis against the Russell 3000 plus 300 basis points with an internal rate of return (IRR) cash flow method. OPERS asset allocation study established the long-term net expected return for an established private equity portfolio to be 10.5%.. This return is based on a mature portfolio consisting of aged exposures and new commitments that are a drag on shortterm performance. VII. RISK MANAGEMENT Private equity does not lend itself to traditional quantitative measures of risk such as standard deviation and benchmark tracking error. Rather, risk is managed through a combination of quantitative and qualitative constraints. The following sections identify the most significant risks with private equity investments and the method of control. A. Liquidity Private equity investments are illiquid and typically have expected holding periods of years. Investments are typically held until maturity and selling prior to maturity results in a discount to fair market value. Liquidity risk is managed by minimizing the possibility of forced sales that may arise from exceeding maximum exposure limits or lowering asset allocation exposure limits. Asset allocation exposure is controlled through the investment pacing described in the Annual Investment Plan. The Board of Trustees has authority to change asset allocation 3

6 targets and recognizes that lowering the private equity target allocation may result in forced sales and increased exposure to liquidity risk. B. Vintage Risk Vintage merely reflects the year of first capital draw and vintage risk refers to the variability of private equity commitments over time. The Annual Investment Plan controls the short and long-term investment pacing that minimizes vintage risk while achieving targeted exposure. Secondary opportunities will be pursued within the Special Situations limits, to gain prior year vintage exposure, further minimizing vintage risk. C. Manager Risk Manager risk consists of two elements, the exposure within a partnership and the number of general partners in our private equity portfolio. Partnership exposure is controlled by limiting the commitment size within a partnership and the maximum commitment to a partnership is the lesser of 25% or $200 million. The 25% limit does not apply to funds committed to a discretionary manager or a separate account. The optimum number of general partners in the portfolio varies with time and is controlled by the Annual Investment Plan. D. Firm Risk Firm risk is the exposure to a private equity general partner and is controlled by limiting the maximum commitment to funds operated by a general partner and its affiliates. The maximum remaining commitment is $400 million in aggregate to a general partner and its affiliates. E. Currency The private equity program accepts the currency risks consistent with the geographic constraints. Private equity partnerships generally do not hedge currency risk and the private equity program will not implement currency hedges. F. Industry Typically, private equity partnerships are permitted to invest in a wide variety of industries with limited controls. Industry risk is controlled primarily through appropriate diversification across classes and subclasses. Targeted industry partnerships such as healthcare, communications, media, manufacturing and energy are each limited to a maximum $75 million commitment and $200 million remaining commitment in aggregate to an industry. G. Geography Geographic risk is controlled through a long-term international target exposure of 25% by market value. International exposure to countries other than Canada, United Kingdom and Western Europe will be limited to a maximum of one fourth of the 25% international target. Global opportunities generally indicate geographic limits and exposure will be attributed and monitored accordingly. 4

7 H. Leverage General partners invest capital from private equity partnerships throughout the capital structure of firms. The capital markets control the maximum leverage available to the general partners and limited partners control leverage exposure through partnership selection and portfolio construction. VIII. ROLES AND RESPONSIBILITIES A. Board of Trustees The Board is responsible for reviewing and approving the Private Equity Policy. The Board will review this document periodically and approve any changes and delegates investment approval authority to the Director-Investments. B. Investment staff Private Equity staff is responsible for recommending the Policy and managing the Private Equity Program under the framework of the Board approved policy. Staff is also responsible for monitoring and reporting to the Board in accordance with the requirements of the OPERS Investment Policy. Investment staff will conduct all due diligence in compliance with procedures established for private equityselect managers in accordance with the General Partner Selection Procedures or through Requests for Proposals. C. Investment advisor(s) Investment staff OPERS may engage a specialty investment advisor(s) to assist in managing the program. Specific responsibilities will be established with the investment advisor(s) through contractual agreements. IX. MONITORING AND REPORTING A. Quarterly Performance report prepared by staff and/ or investment advisor(s). B. Annual OPERS annual Investment Plan submitted by staff 5