Members Present: John Hammond, William Brown, Dennis Callahan, Hunter Calloway, Jay Cuccia, Andrea Fulton, Denny Howell, Frank Marzucco, Jay Middleton, LeRoy Wilkison, Douglas Willis
Members Absent: Jennifer Gilbert-Duran, M. Kathleen Sulick, Howard Brown
Staff Present: John Peterson
Guests: Jess Bolkcom, Charles Grant, Carmen J. Gigliotti, David Moore, Kevin Nee, William J. Rizzo, Sallie Russell-Shuping
Recorder: Laura C. Jackson, Audio Associates
The meeting of the Board of Trustees of the Anne Arundel County Retirement and Pension System (Board) was called to order at 12:12 p.m. by John Hammond, Chair.
Minutes
Mr. Wilkison moved to approve the minutes for the November 8, 2007, Board of Trustees meeting. The motion was seconded by Jay Cuccia and approved unanimously.
Investment Committee
DuPont Capital Management
DuPont Capital Management, wholly owned by the company DuPont, has been managing private equity for more than 25 years. The firm has 44 clients and more than $28 billion in assets under management. About 100 people are broken into four teams that operate as boutique investment firms.
The firm motivates and retains its employees by allowing them to be innovative. Employees are compensated on the basis of a three-tier structure: results firmwide, investment team success and individual contribution.
Mr. Gigliotti spoke to board members regarding the DCM Private Markets Group, which has $4.5 billion in assets. It includes five entities, including the one Anne Arundel County is invested in, DCM Private Equity Fund II.
The members of DCM’s private equity team have an average of 12 years’ industry experience and an average of seven years’ tenure at DCM. As part of its alignment of interests, DuPont invests directly into the fund alongside its clients.
DCM’s investment strategy requires understanding the market, assessing where things are going and conducting diligent premarketing. Private equity managers focus on sectors of the market that are inefficient and look for value that no one else can see. They also concentrate on returns instead of gaining huge revenues from fees.
DCM Private Equity Fund II is fully committed. Mr. Gigliotti reported that all of the county’s investments seem to be doing well. As part of its side-by-side investment, DuPont has invested $820 million into this portfolio. Thirteen percent of the fund is invested in special situations, which are deep-value managers. Twelve percent is invested in venture capital, and 8 percent in mezzanine funds. Thirteen percent also is in co-investments such as Orangina Schweppes and Davis Petroleum.
This portfolio was only nominally exposed to subprime mortgages. There was some exposure to GMAC, which has residential mortgages, but so far the auto financing part of GMAC is doing well.
Mr. Gigliotti said DCM Private Equity II is positioned well in the current market and should see results similar to Dupont’s first fund, Wilton Private Equity. This was a 2001 fund that has performance to date of 22 percent. Mr. Hammond noted that these funds are long investments, so the board doesn’t expect to see dramatic returns for four to five years. Mr. Rizzo said DCM II is positioned to do just as well as Wilton Private Equity within that timeframe. The county has made a $5 million commitment.
DuPont’s private equity investors have been paying fees as soon as they committed to the fund. The firm is proposing a new structure, an annual fund, whereby investors would commit to the fund but not pay a fee until the money is actually called. Among other things, such a change would result in a more efficient fee structure.
BlackRock
Prior to October 2007, Anne Arundel County had investments in the Quellos Group’s QPC II and QPC III funds. In October, BlackRock acquired the Quellos Group LLC’s fund of fund business. BlackRock, a publicly traded company, is a $1.3 trillion asset management firm. By acquiring Quellos, BlackRock acquired an alternative assets business as opposed to building one from within. Merrill Lynch has a 49 percent stake in BlackRock. Mr. Nee said the board members would experience no change in the management of its products.
Mr. Middleton asked how day-to-day routines changed as far as autonomy since the acquisition. The presenters noted no major changes.
As of June 2007, the county’s QPC II fund (Q-BLK Private Capital II) was a little less than 40 percent called. The internal rate of return is a positive 3.9 percent (net of fees), in comparison to the benchmark of negative 90 basis points.
Ms. Russell-Shuping said this asset class stresses the importance of diversification. Through this fund, the county has exposure to venture capital, distressed securities and leveraged buyouts. In the buyout market, BlackRock managers focus on the smaller markets instead of the larger markets to boost returns and reduce exposure to interest rate risk. As a result, about 30 percent of the fund is in small- to middle-market buyouts. Large-market buyouts are less than 10 percent of the fund.
Ms. Russell-Shuping also said that although BlackRock hasn’t had the runup that some firms have seen in the past few years, she doesn’t expect to the see the decline others will experience as the subprime loan problem works itself out.
About 40 percent of the fund is invested in venture capital. Ms. Russell-Shuping said most of these returns occur in the early stages, so 19.2 percent of this fund is in early-stage venture capital.
In response to a question from Mr. Willis about distressed securities, Ms. Russell-Shuping said distressed securities, which are a regular part of BlackRock’s strategy, take advantage of falls in the debt market. Mr. Nee added that BlackRock’s approach tends to be longer term in nature so it seeks funds that will buy those debt securities, take a company through bankruptcy and emerge with equity in that company. Because things may be traded down in the current market, the presenters are pleased the portfolio is in a position to benefit.
In terms of industry allocation, consumer is nearly 18 percent of the fund. About 50 percent of that is technology related, such as Amazon. The fund tends to focus on mature companies as well as technology and health care.
The QPC III fund (Q-BLK Private Capital III) has a different profile than QPC II. Middle-market leveraged buyouts make up more than 20 percent of the mature company strategies. Special situations funds are 13 percent. The fund also has 13.7 percent in late-stage venture capital, but Ms. Russell-Shuping expects early-stage venture capital will be about 27 percent of the venture portfolio. In terms of industry allocation, life sciences (such as a medical device company) make up 16 percent of this portfolio.
Lexington Partners
With offices in New York, Boston, London and California, Lexington Partners manages about $13.6 billion of committed capital. Eighty percent of the firm’s focus is the secondary business, which allows the firm to buy existing limited partnership interests in buyout and venture capital funds from original investors who are looking to get out of that position.
Lexington typically obtains funds that are 80 percent funded and are generally in the fifth or sixth year of the life of that fund. Because Lexington is buying during the harvest phase, it provides lower-risk investments. Lexington also has a complementary business in co-investment funds.
Mr. Grant said information is a key competitive advantage for Lexington Partners. Lexington is an investor in more than 900 funds managed by more than 400 underlying general partners. Lexington relies on an enormous database of real-time information on these underlying positions. The firm also gains insight from personal contacts when making selections.
Anne Arundel is invested in Lexington Capital Partners VI, nearly a $3.8 million fund. Lexington focuses on building a diverse portfolio and selectively choosing the right funds. Mr. Grant said the goal is to build a portfolio that has diverse managers and underlying funds.
About 50 percent of the fund’s primary capital is into buyout funds. About 35 percent is in international—primarily Western European buyout funds. The fund has about 12 percent in venture capital, which is slightly underweight, said Mr. Grant.
Lexington primarily focuses on domestic funds. The firm tends to avoid emerging markets; however, Mr. Grant said Australia has been a good buy-out market.
Because it’s buying mature positions, Lexington gets distributions back fairly quickly. Distributions to date have totaled about 19 percent of contributed capital. He expects distribution levels to slow down somewhat due to problems in the credit market. Overall, however, Lexington is pleased with the portfolio and is in a position to invest over the next 12 to 24 months. The firm expects to enjoy cyclical buying opportunities during that time.
New England Pension Consultants
David Moore met with the board in December instead of Rhett Humphreys, who was in Baton Rouge. The performance flash report was down 3.8 percent in November. All the equity managers were affected by the turbulent market as well as internationals, said Mr. Moore, as people looked to fly away from riskier assets into safer treasuries and fixed assets. He noted that bonds were doing well due to that flight to quality.
Although the performance for emerging markets was down 7.1 percent in November, the month’s results have not affected otherwise stellar returns for the long-term period. The county’s long-term results have been good, he added, because the board has focused on diverse investments.
Commenting on the private equity firms that met with the board in December, Moore said he expected Dupont and BlackRock to get higher returns. Lexington is not as risky.
Administrative Report
John Peterson reported that two staff vacancies have been filled. A pension analyst and a personnel assistant will begin on the 27th.
The board is in its third year of a three-year commitment with its outside auditor. The board will need to bid for new outside auditors, so Mr. Peterson will need an evaluation committee.
Hamilton Tyler and Lori Blair from the county’s Office of Law spoke to the board regarding its ongoing issues with Prudential. During the October meeting, Mr. Hammond reported that Prudential planned to cease making payments to about 23 surviving spouses on the first of November. The company believes the annuities the county had for police officers and firefighters were annuities on the lives of the employees and didn’t cover spouses. Prudential later agreed to pay benefits to the surviving spouses for November.
Because Prudential will not make payments to the surviving spouses in the future, the board has decided that the survivors will get their benefits starting January 1. Mr. Peterson said the board is prepared administratively to pay everyone in January.
The potential liability for past payments to Prudential is at worst $4.3 million. The board will continue to work with the county to determine action that needs to be taken
Action: Dennis Callahan made a motion that the board agrees that the county should pay the existing Prudential spousal beneficiaries so there is no gap in their benefits. Mr. Wilkison seconded the motion. The motion unanimously passed. .
The board will continue to pursue this issue and investigate a number of different strategies, including buying the business back from Prudential.
Mr. William Brown provided a Statement of Plan Net Assets for September 30, 2007. Total net assets held in trust for pension benefits are $1.4 billion.
He also noted that the pension system was awarded a certificate of excellence in financial reporting for the second consecutive year. The award recipient was Janet Morgan.
