A more selective Connecticut tries to find its groove

Connecticut closed on $480 million of new commitments across seven 2012 to 2014 vintage-year funds as of March 31, according to a report compiled by adviser Franklin Park that was obtained by Buyouts.

The $29.4 billion retirement system’s $125 million commitment to Apollo Global Management’s latest flagship fund, along with re-ups to the well-regarded buyout shop Levine Leichtman Capital Partners and secondary buyer Landmark Partners, mark a departure from a pre-financial crisis strategy that had it committing as much as $1.2 billion per vintage year across a broad selection of managers, several of which turned out to be sub-par. The approach left the state heavily exposed to pre-recession vintage funds that have hurt returns, according to Franklin Park.

All told, Connecticut has committed $7.4 billion across 91 private equity and venture capital vehicles since 1987, according to the Franklin Park report. The state has a 9.2 percent allocation to private equity and venture capital, leaving it well below its 11 percent target. The private investment fund was valued at $2.6 billion as of March 31.

The performance has not been great. Connecticut’s private equity portfolio was netting an internal rate of return of just 8.8 percent since inception as of March 31, according to Franklin Park, underperforming its public market equivalent benchmark (the S&P 500 index plus 500 basis points) by 240 basis points.

Among the biggest reasons, the retirement system invested aggressively in the years leading up to the collapse of the dot-com bubble. The state committed roughly $2.45 billion to private equity and venture capital across 34 funds between 1997 and 1999, according to the report. Of those 34 funds, 13 ended up generating bottom-quartile returns for their vintage years. Seven of those bottom-quartile funds, including large bets on two underwater Forstmann Little vehicles, were fully realized as of Dec. 31.

The system’s commitments of $1.1 billion to 1998 vintage funds have been particularly troublesome. Those funds had generated a net IRR of just 2.8 percent as of Dec. 31. Altogether, the state’s investments in pre-2002 vintages had produced a net IRR of 7.9 percent as of March 31. We were unable to reach executives at Connecticut for comment on this article.

Scandal

The late 1990s and early 2000s proved tumultuous for the state’s private equity portfolio for other reasons.

In 2003, former Connecticut State Treasurer Paul Silvester was sentenced to 51 months in jail for his involvement in a pay-to-play scheme involving private equity funds that took place from 1997 to 1998. Current Treasurer Denise Nappier took office in 1999, and Franklin Park replaced INVESCO as Connecticut’s private equity adviser in 2004.

Under Nappier, Connecticut quickly slowed its commitment pace. The state has no exposure to 2000 or 2001 vintage funds and pledged just $420 million across seven funds that qualify as 2002-2004 vintages.

As the economy improved in the mid-2000s, many private equity managers began to pursue larger deals and larger funds. Connecticut responded in kind by increasing the size and scope of its private equity program. The retirement system committed $1.7 billion between 2005 and 2007, including $688 million across eight 2006 vintage funds, its highest total since before the dot-com collapse.

The decision to ramp up commitments to 2005-2006 funds, of course, ultimately backfired. “Vintage years 2005 and 2006 have delivered disappointing returns for the private equity industry and PIF’s (private investment fund’s) exposure to those vintages has detracted from aggregate results,” according to the Franklin Park report.

Making the situation worse was poor manager selection. Eight of the retirement system’s 13 active fund commitments from 2005 to 2006 have generated third or fourth-quartile returns, according to Franklin Park, and two of the retirement system’s worst-performing funds belong to those vintages.

Nogales Investors’s second buyout fund terminated its investment period early after a key-person event, according to Franklin Park. In 2010, one Buyouts source called the firm “a rudderless ship” after three executives left the firm. Fund II was generating a negative 2.6 percent net IRR for the state as of year-end.

Connecticut’s exposure to 2006 vintages also includes an investment in Syncom Venture Partners’s fifth fund, which was generating a net IRR of -17 percent as of Dec. 31. “The manager has written down most of the fund’s holdings,” according to Franklin Park.

Neither firm appears to have raised a fund since their 2006 vintages. Executives at Syncom and Nogales could not be reached for comment.

Connecticut tapered its commitment pace slightly in 2007, committing $550 million across five funds. That vintage has performed well, netting 14 percent for the state on the strength of enterprise software specialist Vista Equity Partners’s third fund (31 percent IRR as of Dec. 31, according to Franklin Park) and Fairview Capital’s Constitution III fund (18 percent IRR).

With the exception of a significant uptick in commitments in 2011, when it allocated $524 million to private equity and venture capital funds, Connecticut appears to have smoothed out the pace of its commitments since 2009, pledging between $100 million and $300 million across fewer managers.

That smoothing coincided with the arrival of new staff. Lee Ann Palladino replaced M. Timothy Corbett as chief investment officer in 2011. Private equity chief Adrian Kingshott left Connecticut in 2012 after three years. The private equity portfolio is currently overseen by Terrence Purcell.

The adjustment has had an effect on performance. Despite the J-curve effect that tends to dampen returns early in the lives of funds, 2010 to 2014 vintage-year funds had generated an 11.2 percent net IRR for the state, according to Franklin Park. That compares to 8.8 percent for pre-2010 funds.

With any luck, the slower pacing and higher selectivity of Connecticut’s private equity commitments will improve long-term performance, providing a blueprint for other limited partners with large exposures to troubled vintages.