Exploring Asset Allocation Strategies Across LPs: Pensions, SWFs, and Endowments

As LPs have sought to incorporate private equity into their investment strategy, many have looked to emulate the Yale model (or some version of it) pioneered by David Swensen. However, integrating private equity into an allocation framework varies significantly among different LPs, determined by the distinct circumstances surrounding their liabilities, investment objectives, and risk tolerance.

In this article, we delve into the evolution of private equity asset allocation among institutional investors, exploring shifts influenced by current macro events within the portfolios of three distinct types of limited partners: a sovereign wealth fund, a state pension, and an endowment, including how their investment objectives and specific circumstances have shaped their forward-looking approach to their private equity targets.

Alaska Permanent Fund Corporation

LP Type: Sovereign Wealth Fund
AUM (‘23): $78.0 B
Private Equity Allocation (Actual ‘23): 20%
Private Equity Allocation (Target ‘23): 17%

About: Enacted in 1976, the Alaska Permanent Fund Corporation (APFC) was created to provide a renewable, perpetual, and diversified revenue source, recognizing the limitations of oil reserves for long-term wealth generation. The fund serves three key functions: saving, generating income, and providing economic stability, channeling a portion of Alaska’s natural resource wealth into a well-diversified portfolio to convert non-renewable resources into income-producing financial assets.

Today, the APFC stands as the largest sovereign wealth fund in the US, with its initial deposit of $734 thousand growing to over $78 billion in principal and earnings reserve accounts (ERA). Historically, the ERA was used only to pay dividends to eligible Alaskans, as the state had sufficient resources to support the annual budget. However, Alaska’s natural resource economy has undergone significant transformation since the fund’s inception, leading to APFC gradually taking more and more of a role in supporting the state’s fiscal needs in addition to its annual Permanent Fund Dividend (PFD) it distributes to Alaska residents.

Portfolio Construction and Private Equity

Leveraging its scale, capacity for longer-term investment horizons, and structural flexibility, the Alaska Permanent Fund Corporation (APFC) has actively pursued a significant private equity allocation, more than doubling its PE target over the past decade under the leadership of Steve Moseley. Despite limited liquidity, its private equity portfolio has historically provided a stabilizing force within the fund’s portfolio by offering diversification across various industries, geographies, and stages.

However the APFC didn’t always embrace private capital markets to the degree it does today, and the evolution of private equity adoption within its allocation framework is especially captivating:

  • Origins: In 2004, APFC commenced its private equity program with a singular commitment to Pathway Capital Management to deploy on its behalf.
  • Program scaling: In 2005, though APFC only had a PE portfolio with $6M in fair value and the program was only two years old, its commitments had already climbed to $300M.
  • Expansion: In 2009, APFC enlisted HarbourVest as its second manager to collaborate with Pathway in overseeing the PE strategy.
  • Talent acquisition: In 2014, Steve Moseley joined APFC as part of the PE team.
  • Progressive tactics: During 2015, APFC was a pioneer of a few innovative PE strategies, notably committing $550M to Dyal Capital Partners’ (now Blue Owl) GP stakes strategy.
  • PE boost: Upon Steve Moseley’s arrival at APFC in 2014, the PE allocation stood at 6%. Throughout his tenure, which concluded in 2022, he steered the fund to increase the actual PE allocation to 20%.

Additionally, since APFC initiated its PE program in 2004, a few striking statistics are worth mentioning:

  • Commitments: In 2004, Alaska committed solely to Pathway Capital Management. In 2023, it reported 411 unique fund commitments.
  • Co-investments and directs: In 2011, the first co-investment appeared in APFC reports. This direct investing strategy has since scaled to 39 unique investments.

Looking Ahead

Several factors have impacted the APFC’s forward-looking approach to its PE allocation. While the fund generated a positive return on invested assets of 5.18% in 2023, given the current market environment, the amount of income generated via investment activity has decreased. Consequently, the spendable portion of the fund is depleting faster than it is being replenished, a critical issue given the fund’s growing responsibility in funding the state budget while simultaneously distributing the PFD.

Further, swift declines in APFC’s liquid assets in 2023 caused the fund to surpass its 17% private equity target, reaching about 20%. These factors have prompted the fund to reconsider its private equity allocation, resulting in a slowed commitment pace and a reduction in allocation targets over a two-year period. The PE allocation has been adjusted to 16% for 2024, with a further reduction to 15% set for 2025. This new future target has already had real-time operational effects, as APFC will deploy $1 billion this year across its PE strategy, compared with a typical annual budget of $1.6 billion to $1.8 billion.

Increasing interest rates have largely influenced the strategy shift. In a recent interview with PEI, Allen Waldrop, the APFC’s new PE Director, cited the current interest rate environment as a catalyst for reducing the fund’s PE exposure. Given favorable returns in fixed income, he highlighted that assuming greater risk and volatility has become less essential for the fund to achieve its primary goal of increasing/maintaining principal. However, he emphasized the fund’s continued opportunism in private equity, highlighting the ongoing potential to invest in high-quality assets at more favorable prices.

Princeton University Endowment

LP Type: University Endowment
AUM (‘23): $34.1 B
Private Equity Allocation (Actual ‘23): 39.9%
Private Equity Allocation (Target ‘23): 30.0%

About: Princeton University’s Endowment, managed by The Princeton University Investment Company (PRINCO), is tasked with the goal of consistently supporting the university’s current and future operating needs while maintaining value for future generations. To achieve this, the endowment targets a return surpassing the combined annual spending rate and “university inflation,” emphasizing a focus on long-term returns exceeding 10% annually.

Portfolio Construction and Private Equity

In crafting its asset allocation strategy, PRINCO capitalizes on key advantages, notably its perpetual time horizon and minimal spending requirements. These factors empower the fund to navigate heightened volatility and lower liquidity, placing a pivotal emphasis on private equity, with the endowment pursuing an above-average exposure to this asset class. Much like Yale’s portfolio, discussed in our previous article, PRINCO has had a substantial allocation to alternatives more broadly since the 1990s and has steadily grown this target through last year.

This strategy has successfully contributed to the endowment’s superior long-term performance. Private equity has generated a 19.4 percent return over the past five years relative to a 4.6 percent return for the endowment (excluding private equity).

Perhaps these impressive results are unsurprising as Andy Golden – current president of PRINCO – was trained and mentored by David Swensen and Dean Takahashi at Yale’s investment office. The Yale Model tenants of increasing exposure to alternatives, emphasizing the importance of manager selection, and carefully forecasting cashflows are clearly carried over to this endowment.

Further, Princeton’s robust financial position and esteemed reputation afford it the flexibility to adopt a distinctive approach to its private equity investment strategy, employing a “bottom-up approach” that prioritizes long-term partnerships with managers. For example, PRINCO is frequently the first investor in a new fund, with the endowment continuing to back managers through subsequent fundraises – a successful model that has also been utilized by other fund allocators like Sapphire Partners. Additionally, the $35 billion endowment prefers working with a small roster of managers, which often entails large allocations to specific funds, increasing concentration risk.

These preferences draw intriguing comparisons with APFC, which, despite sharing lower liabilities, adheres to a more stringent mandate in its asset allocation requirements. For example, APFC limits manager concentration in its private equity portfolio to a maximum of 20% committed to any individual manager. Additionally, the APFC mandates specific diversification ranges within its private equity portfolio, designating specific targets for venture capital, growth equity, and buyouts, while Princeton enables a more flexible distribution.

Looking Ahead

The denominator effect reared its head in Princeton’s portfolio over the past two years. Falling aggregate portfolio value caused the private equity allocation to ”surge” to 39%, surpassing its 30% target. As a result, last year, PRINCO employed a defensive positioning strategy in their portfolio, motivated by their higher-than-typical PE exposure coupled with very high U.S. equity market valuation levels.

This included taking advantage of the endowment’s ability to widen mid-term allocation target bands without adjusting their broader policy targets, which included reducing their mid-term target for fixed income and cash from 13% to 9% and increasing the mid-term target for private equity from 35% to 37%.

This ability to modify mid-term allocation bands without changing long-term policy targets underscores the distinctive flexibility afforded to institutions like Princeton due to their long-term investment horizons and limited liabilities. As described below, this luxury is not afforded to all LPs.

Maine Public Employees Retirement System (MainePERS)

LP Type: Public Pension Plan
AUM (‘23): $19.8 B
Private Equity Allocation (Actual ‘23): 19.5%
Private Equity Allocation (Target ‘23): 12.5%

About: The Maine Public Employees Retirement System (MainePERS) administers six defined benefit retirement programs that cover state employees, the state’s public school teachers, judges, legislators, and employees of the 327 municipalities. The defined benefit programs’ assets perform two functions: they collateralize the benefits owed to participants, and they provide investment earnings. Therefore, the pension has adopted an asset allocation strategy to optimize returns on contributions to achieve investment objectives while minimizing investment risks.

Portfolio Construction and Private Equity

Similar to many pensions, the prolonged low-interest-rate environment posed challenges to MainePERs regarding the viability of the fund’s traditional asset allocation strategy for meeting defined benefit plans. To achieve targeted returns, the fund had to move assets away from fixed income and enhance diversification through increased allocations to various alternative asset classes, exemplified by the pensions PE allocation, which has significantly grown over the past several decades. Additionally, the portfolio has seen a large increase in alternatives since the late 2000s, transforming the portfolio’s target allocation to alternatives in aggregate from less than 5% to a comfortable majority today.

Looking Ahead

Interestingly, MainePERS’ future PE allocation is currently being influenced by legislation made in the 1990s. In 1995, when the pension was less than 30 percent funded, Maine voters made a bold move by approving a state constitutional amendment to eradicate unfunded liabilities by 2028. Despite exceeding an 86% funding ratio and being considered one of the nation’s well-funded pensions today (see below), MainePERS adjusted its allocation strategy in 2022 to address looming liabilities associated with the amendment’s deadline. This strategic plan lowered its private equity target from 15 percent to 12.5 percent to boost liquidity and curb contribution volatility.

For example, by reducing its private equity allocation, MainePERS aims to curtail risk with a minimal impact on returns and alleviate pressures linked to unfunded actuarial liabilities by reducing its private equity allocation.

Managing changing contributions is a key consideration for MainePERS, as the pension grapples with the task of paying more retirees than the number of current contributing employees, heightening liquidity concerns. Even with a reduced target private equity allocation of 12.5%, the fund remains overallocated at approximately 20%. With this in mind, the current environment of stressed returns coupled with ongoing contribution volatility means MainePERS has encountered increased challenges in terms of asset allocation.

This is part two in our three-part series exploring asset allocation strategies and trends. Stay tuned for part three, exploring how LPs can leverage cash flow forecasting models to optimize private market allocations, commitment pacing, and cash flow management.

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