Members Present: John Hammond, Howard Brown, Dennis Callahan, Jay Cuccia, Janelle Davis, Richard K. Drain, Andrea M. Fulton, Jonathan Hodgson, Jay Middleton, M. Kathleen Sulick, LeRoy Wilkison
Members Absent: Jennifer Gilbert-Duran
Staff Present: Janet Morgan, John Peterson
Guests: O’Brien Atkinson, Bruce Emge, Reshma Ketkar, Craig Payne, Michael Pilson, Eric R. Harnish, 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 12:15 p.m. by Mr. Hammond.
Minutes
Mr. Callahan made a motion to approve the minutes of the July 9, 2009, Board of Trustees meeting. The motion was seconded by Mr. Cuccia and approved unanimously.
Investment Committee
DuPont Capital Management
DuPont Capital is the asset management arm of DuPont Company. Its biggest client is DuPont’s pension fund. The firm also serves 40 to 50 public pension funds, endowments, foundations and other clients. DuPont has managed funds for the county’s pension system for about 3 years.
About 20 percent of DuPont’s assets are in private equity, which the firm has managed since the late 1980s. The current investment team has been in place since 2001 and has committed more than $3 billion to 168 investments.
DuPont seeks to buy companies cheaper than they are worth in order to control and create a more valuable enterprise. The firm also focuses on working with managers who can create value and aligning its interests to ensure common goals. In response to a question from Mr. Callahan, Mr. Pilson noted that the county pension system’s investments are the same as DuPont’s.
Because of the turbulence in the market, the DCM Private Equity Fund II has a negative net IRR of just under 15 percent. The fund has done better than the public performance, said Mr. Pilson, but managers still are unhappy with its results. As a result, the firm has spent time analyzing the companies in the fund and whether the fund’s results stemmed from manager mistakes or valuation adjustments in the market. Generally across private equity and in other asset classes, managers bought companies too quickly during the time of peak pricing, said Mr. Pilson.
Sixty percent of this diversified portfolio is called, which means 40 percent of the capital remains and can go into a much better environment, said Mr. Pilson. DuPont has examined which managers still have undrawn capital and how those managers will use that capital from 2009 to 2011. Most of the commitments in the fund are buyouts, special situations/mezzanine and co-investments/secondaries, he added. Venture capital makes up only 12 percent of the sector allocation. The fund includes a mix of international and U.S.-based funds.
Despite returns, Mr. Pilson said DuPont is pleased with the quality of the companies in DCM Private Equity II. The fund’s No. 1 holding as a company, he said, is a private label razor manufacturer that’s well positioned for the current economic environment. DuPont also has large exposure to a company that operates a railroad. Unlike hot businesses that come and go, these companies should take advantage of cost-conscious consumers’ focus on staples and the asset backing of tried-and-true services.
Reviewing the current economic environment, Mr. Pilson noted limited activity in the private-equity market, but DuPont can take advantage of pricing inefficiencies in secondary investments and credit strategies.
Companies continue to watch debt levels, cut costs and conserve cash. Rather than using cash for acquisitions, businesses are concentrating on their own companies. Mr. Callahan noted that with the type of companies in DCM Private Equity II, DuPont would need time to recoup its losses. Mr. Pilson agreed that the fund could require 5 to 8 years to break even. However, he said, all the funds aren’t down 15 percent and managers seek to grow these funds quickly.
Mr. Callahan also asked whether fund managers should move slowly or act quickly to take advantage of market opportunities. Mr. Pilson said fund managers haven’t lost anything by sitting on the sidelines and reserving cash. Waiting for the markets to stabilize was probably the wiser course during the past two years, he said. He expects to see more activity in the fourth quarter.
Blackrock
With headquarters in New York, Blackrock has $1.37 trillion in assets under management, and its acquisition of Barclays Global Investors is pending, said Ms. Ketkar. BGI has no private equity exposure or expertise, so she anticipated no change to Blackrock’s operating structure or the team that serves the county pension system.
Within its private equity portfolio, Blackrock has $6.2 billion of investor commitments. The names of the county’s pension system funds have changed to the Venture Capital and Growth Fund (VCG), although the strategies remain the same. Blackrock plans to roll out a successor fund called VCG IV.
Although the current market has brought attention to distressed and turnaround investing, Mr. Payne noted increased interest in smaller companies. The purchase prices are lower and more leverage is available, he said. He also noted more add-on activity as firms purchase one company and then buy other small companies in the same space to create a bigger enterprise to sell for a premium in the future.
Ms. Ketkar added that neither of the county’s funds are fully drawn, and VCG III has a significant amount of capital available to take advantage of current opportunities. VCG II, an ’04/’05 vintage fund, is 65 percent drawn. VCG III, the ’06/’07 vintage fund, is 25 percent drawn. Mr. Hammond noted that both funds are fully committed.
In reviewing a snapshot of VCG II, Mr. Payne reported good and bad news. Looking at performance, the fund is underwater with a net IRR of -8.9 percent. Three investments in this portfolio accounted for 50 to 60 percent of the shortfall of Blackrock’s performance relative to the top quartile benchmark, he said.
Sun Securities II, which invests in minority distressed positions, struggled to gain control of its deals, which led to a significant markdown of that fund. Another investment suffered from losses in the retail sector. The third, a technology company, ran out of capital and got caught in the credit crunch. On the other hand, a group called OCMGFI, which focuses on oil and gas services, has had some early successes, and Inside Equity, which seeks lower- and mid-market buyouts, is marked at 2.3 times cost, said Mr. Payne.
Mr. Hammond asked about Fortress fund IV. Fortress has certainly experienced hard times, said Mr. Payne. Managers invested Fortress IV a little bit earlier. It has a significant number of public exposure and real estate investments, including senior living. This sector has faced turbulence as families save costs by relying on other types of living arrangements for elderly relatives. However, the fund includes some good companies. Fortress V, invested right during the peak, has struggled a bit more, said Mr. Payne.
Another fund in VCG II, Sun Capital Partners IV, is a large portfolio of 45 to 50 investments. DuPont has written down a number of companies that had retail and casual dining exposure. However, this is a $1.5 billion fund that often succeeds with $5 to $10 million investments. The fund has grown quickly so DuPont watches it closely, said Mr. Payne.
VCG III is still in its early stages, he added. The fund is at 0.77 times cost versus the benchmark’s performance of 0.95 times cost. Fortress V accounts for more than half of the difference between DuPont and the top quartile, he said. A $25 million investment, Fortress V drew capital quickly and managers deployed the funds into mortgage-backed securities, casinos and other investments right before the markets fell in 2007.
He noted that Ventizz, which does tech-oriented buyouts in German-speaking Europe, has already realized one investment over 2 times cost. VCG III is still early in its lifecycle, however, and a good deal of capital remains available to draw, he said.
New England Pension Consultants
NEPC’s Eric Harnish met with the board this month instead of Rhett Humphreys. He is a senior consultant who focuses on private equity research.
Sharing a few thoughts on the private equity markets, Mr. Harnish said fund raising has been difficult and limited amounts of credit are available. This is a time to be defensive; however, the pension system still can capitalize on market conditions. He expects the distressed investment strategy to exist for multiple years.
Mr. Harnish reviewed the equity performance of the fourth quarter of 2008. In the private equity plan, the pension system had a negative year as of December 31st, with a nominal IRR of -12 percent and -19 percent for the year. However, the private equity industry as a whole generated losses of 16 to 18 percent in the fourth quarter. The public equities market reported losses in the range of 22 to 23 percent. This indicates the effect of the county’s J curve mitigation strategies, he said.
Reviewing the second quarter 2009 Executive Performance Report, Mr. Harnish reported good results across a wide range of market indices. Further, the pension system’s ranking, as compared to the consultants’ universe of performance, was improving throughout the year. However, the county will need a great deal of time to recover 2008 losses, he said.
The flash report for the period ending July 31, 2009, showed positive returns for international equities and core fixed income.
In other business, Mr. Hammond distributed the minutes from the August 6, 2009, investment committee meeting.
Administrative Report
Mr. Peterson reported that the latest issue of Pension Points has gone out in the mail. Also, Mr. Cuccia won re-election and will retain his seat on the board.
State law was changed regarding the funding responsibility for County elected officials who participate in the State plan. Up until this year the state paid the employer cost for these members. Going forward, the County will be billed for the employer share. The only person this currently applies to is the County Sheriff. The current State's Attorney for Anne Arundel County is participating in the County's plan.
Mr. Emge addressed the board with his concerns about negative cost of living adjustments and reduced benefits for retirees. Mr. Hammond said the board would consider putting a cap on how far benefits could decrease.
The meeting adjourned at 1:55 p.m. The next meeting will take place September 10.
