Members Present: John Hammond, O’Brien Atkinson, Dennis Callahan, Jay Cuccia, Richard K. Drain, Jennifer Gilbert-Duran, Jay Middleton, M. Kathleen Sulick, LeRoy Wilkison
Members Excused: Howard Brown, Janelle Davis, Andrea Fulton, Frank Marzucco
Staff Present: John Peterson, Janet Morgan
Guests: Mark M. Andrew, Tim Costello, Rhett Humphreys, Susan Powers
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 12:18 p.m. by John Hammond.
Minutes
LeRoy Wilkison moved to approve the minutes for the January 8, 2009, Board of Trustees meeting. The motion was seconded by Jay Cuccia and approved unanimously.
Investment Committee
Lexington Partners
Lexington Partners is the largest independent player in the secondary market with more than $15 billion of pro forma secondary capital and more than 250 secondary transactions completed. Lexington is invested in more than 900 funds managed by 450 GP sponsors.
The firm has 55 staff members in New York, Boston, London and Menlo Park. Mr. Andrew reported no turnover among staff.
Anne Arundel County is invested in the Lexington Capital Partners VI fund. Total capitalization of this fund is 3,774 million. In the fund are more than 140 partnerships managed by 92 sponsors. The fund is 88 percent committed, with deals ranging from $1 million to $260 million, said Mr. Andrew.
Nearly 40 percent of the transactions in LCP VI are spin-out transactions with existing managers, said Mr. Andrew. LCP VI’s sponsors include Kohlberg Kravis Roberts & Co., Bain Capital and Lindsay Goldberg. RBS Asset Management is one similar spin-off transaction.
Reviewing sector diversification, Mr. Andrew said Lexington has a very small percentage invested in 2006-2007 mega buyout vintage years because the firm doesn’t want to overcommit to that part of the market. Other sectors in LCP VI include U.S. buyouts (58 percent), Non-U.S. Buyouts (23 percent) and U.S. venture capital (15 percent).
Mr. Andrew noted that strong performance of PE, particularly in 2004 through July 2007, led to lower discounts in the secondary market. Today, discounts are expanding sharply due to increased supply of opportunity and urgency among sellers needing liquidity. This is a time of tremendous opportunity for Lexington Partners, he said.
The LCP VII fund will raise money through the third quarter of 2009. The terms of LCP VII will be similar to VI. However, Mr. Andrew expects this fund to look more like Lexington V in terms of types of transactions because of the market and significant opportunities in distressed selling.
Mr. Callahan asked if Lexington is receiving cash on time. Mr. Andrew said there have been no problems.
Mr. Hammond asked if the need for liquidity is driving the interest in Lexington Partners. Mr. Andrew said yes, particularly for certain segments. Liquidity is a major issue for some campus endowments, he said, and banks want to reduce private equity commitments.
Mr. Hammond wanted to know about risks in Lexington’s model. Mr. Andrew said incorrect projections would seriously affect Lexington’s results. Fund managers must buy correctly, he said.
Newstone Capital Partners
Newstone was founded by Timothy Costello and John Rocchio. The firm provides mezzanine capital to private equity sponsors pursuing leveraged transactions. Newstone has completed 18 transactions totaling $709 million with leading private equity sponsors.
Newstone targets larger, middle-market private equity firms and focuses on principal preservation. The firm spends 3 to 6 months on due diligence analysis, talking to customers, suppliers and trade associations and building its own file of information.
Mr. Costello said leverage is coming down, which means Newstone takes less risk. Spreads are widening, so the firm receives better return for that risk. However, managers must use caution in this tough economy.
Mr. Costello also noted increasing second-lien spreads. Four years ago, Newstone didn’t do a lot in this area, but today all of these deals need mezzanine. Buyout volume is slowing down and creating somewhat of a cherry-picking process. Newstone might pursue 25 deals and close only 5 to 10, he said.
The portfolio, which is 82 percent vested, generates more than $75 million of income per year. Companies in the portfolio includes Jen-Coat, Inc., PETCO Animal Supplies Inc., Jacuzzi Corp. and Concrete Technologies Worldwide. Newstone has won a lot of repeat business from companies it has worked with during the past 15 years, Mr. Costello said.
Mr. Hammond asked about any problems with the companies in the portfolio. Mr. Costello said Jacuzzi is on the firm’s watch list because of the company’s connection to housing and consumers’ discretionary spending. Newstone expected some decline in housing but not as much as what has occurred. Jacuzzi should weather the storm but 2009 could be a difficult year, he said.
New England Pension Consultants
Mr. Humphreys discussed the fourth quarter Executive Performance Report. Reviewing equity manager returns, Mr. Humphreys said the pension system’s performance during the past three months was -17.5 percent. The quarterly return placed the fund in the 99th percentile of peer public funds. Returns for the last year were -30.4 percent, placing the pension system in the 99th percentile of public fund portfolios.
Looking at the policy index, Mr. Humphreys reported returns of -23.1 percent for the year. Even so, the county’s pension system ranked in the top third of the country’s public funds. On the other hand, several managers used a concentrated portfolio, which didn’t work well for the county, said Mr. Humphreys. Gottex, for example, had returns of -53.5 percent for the year compared to a benchmark of -37 percent.
Some of that poor performance in active management reversed itself in the January flash report, said Mr. Humphreys. Western had returns of 1.1 percent and Penn reported 6.5 percent. Bridgewater posted 0.3 percent.
In reviewing ING Clarion, a real estate portfolio, Ms. Sulick asked how NEPC validates the information it receives regarding the properties in the fund or strategy changes. In addition to relying on auditors, NEPC research teams review quarterly reports to double-check information, said Mr. Humphreys.
Mr. Humphreys mentioned a significant personnel change at ING. Ms. Christine Hurtsellers will replace Mr. Jim Kaufmann as head of public fixed income. Ms. Hurtsellers has more than 21 years of investment experience and has been in charge of structured finance since 2005. However, Mr. Humphreys said, she had input into some of ING’s decisions that have led to its poor performance.
NEPC recommends putting ING on a watch list for possible termination if turnover continues or performance continues to lag. Reviewing ING’s performance for last year, Mr. Humphreys reported -8.4 percent in comparison to -5.2 percent for the benchmark. That type of performance is unheard of for a more traditional fixed income portfolio and is much more of a concern, he said.
As part of its asset allocation analysis, NEPC assumes a return to normal markets within the next 7 years. A small but credible risk of a long-term deflationary spiral exists. NEPC encourages clients to position for opportunities but size risk positions appropriately, consider broader risks of the total investment program, prepare for continued market volatility and assess liquidity needs and commit capital accordingly.
Administrative Report
Mr. Peterson said the personnel staff has been overwhelmed with applications to the DROP program. Fifteen new people came into the program last year; this year has already seen nineteen new entrants, he said.
The staff also is completing its portion of the pension audit and working on pension valuation.
Mr. Peterson reported that three pension system board members’ seats are up for election this year: Jay Cuccia, LeRoy Wilkison and Kathleen Sulik.
The board still seeks a replacement for Mr. Hunter Calloway.
The meeting adjourned at 2:07 p.m. The next meeting will take place March 12.
