Record year for deal value vaults venture capital, private equity

After years of allocation shifts toward private assets, alternative investment portfolios of the 200 largest U.S. retirement funds climbed sharply in 2021, as high as 85% in some sectors, pushed skyward by a combination of strong returns and fierce transaction activity.

Venture capital and private credit were the fastest-growing alternative investment asset classes tracked by Pensions & Investments' annual U.S. retirement plan survey, increasing 85% to $83.9 billion and 77% to $89 billion, respectively, in the 12 months ended Sept. 30. Private equity, which includes venture capital, increased 55.3% to $680.8 billion, with buyouts rising 48% to $381.2 billion.

Real assets, while seeing double-digit percentage growth for the 12-month period, didn't hit the highs of private equity and private credit. Infrastructure was up 39.5% to $57.6 billion, real estate investment trusts rose 22.1% to $34.2 billion and real estate equity was up 13.4% to $418.3 billion.

Helping the increases in venture capital and private equity was that 2021 followed a somewhat less active year in terms of number of transactions, which slowed considerably between March and September 2020, providing a lower baseline for comparison, said Adam Bragar, New York-based head of the U.S. private equity practice of Willis Towers Watson PLC. This was reflected in last year's survey results. Private equity rose 9.6% in the year ended Sept. 30, 2020, with buyouts up 17.8% and venture capital up 5.6%.

Still, 2021 by itself was a very busy investment activity year for private equity and venture capital compared to any year in history, Mr. Bragar said.

U.S. private equity deals had a total value of $787.6 billion as of Sept. 30. By year end, transaction value had grown to $1.2 trillion in 2021, more than 50% higher than the previous record in 2019 and well above the $689.6 billion of total transaction value in 2020, according to PitchBook Data Inc., Seattle.

Meanwhile, U.S. venture capital transaction value was $238.7 billion as of Sept. 30. Deal values ended 2021 at $329.9 billion in 2021, nearly double the previous record of $166.6 billion in 2020, the latest PitchBook-National Venture Capital Association report shows.

A number of factors converged to make 2021 a record-breaking transaction year, including a growing number of very large private equity funds seeking $20 billion or more, Mr. Bragar said.

For example, Hellman & Friedman closed one of the largest buyout funds ever in 2021, Hellman & Friedman Capital Partners X, at its $24.4 billion hard cap, and technology-focused private equity firm Silver Lake closed its latest buyout fund, Silver Lake Partners VI, at its $20 billion hard cap in January 2021. Blackstone Inc. closed the then-largest private equity fund ever raised at the end of 2019 at $27 billion and is expected to seek $30 billion for the next fund in the series, according to PitchBook.

During Blackstone's fourth-quarter earnings call on Jan. 27, President and Chief Operating Officer Jonathan D. Gray said that over the next 18 months, the firm plans to launch and substantially close 17 funds targeting a total of about $150 billion.

Last year was also a record-setter for U.S. venture capital fundraising, at $128.3 billion, a 47.5% increase from 2020, according to the PitchBook-NVCA report. Mr. Bragar said fundraising activity is "going to mean a significant increase in investment activity."

U.S. private equity funds raised $301.3 billion in 2021 with megafunds — those with total capital of at least $5 billion — accounting for roughly 48% of the total, according to PitchBook. By comparison, U.S. private equity funds raised $272.2 billion in 2020.

Coupled with the increased demand, a greater number of company owners were willing to sell as the COVID-19 pandemic motivated them to do so in 2021, Mr. Bragar said. What's more, some company owners were prompted to sell over fears that the Biden administration would increase corporate and other taxes, Mr. Bragar said.

At the same time, investors are still placing an increasing percentage of their total portfolios into venture capital and other private equity asset classes as their returns are expected to exceed those of global equities, Mr. Bragar said.

Also, a low-interest-rate environment has made the returns of those alternative investments even more attractive, he added.

As of June 30, U.S. private equity funds had a 56.2% internal rate of return for 12 months, annualized 21.1% for five years and annualized 16.8% for 10 years, Pitchbook data show.

Indeed, Washington State Investment Board, Olympia, attributes part of the 51% growth of its buyouts portfolio over the year, at $27 billion as of Sept. 30, to performance. The board oversaw $161.5 billion in retirement plan assets, including $135 billion in defined benefit plan assets. "It was a remarkably strong year for many of our buyout funds," said Chris Phillips, director, institutional relations and public affairs, in an email.

The $496.8 billion California Public Employees' Retirement System, Sacramento, and the $313.9 billion California State Teachers' Retirement System, West Sacramento, were one-two on P&I's list of the largest buyout investors. CalPERS' buyout portfolio grew 68% to $33.8 billion and CalSTRS' portfolio was up 56% to $32.5 billion.

Pointing to the growth of its alternative investment portfolios, CalPERS interim CIO Dan Bienvenue said in a statement that those asset classes are integral to achieving the pension fund's expected rate of return. "In order to achieve our target return of 6.8% and to diversify our portfolio to reduce risk, we need to take advantage of opportunities in the private markets that align with our total fund objectives," Mr. Bienvenue said.

As for overall private equity, Washington State Board's portfolio was up 54% to $37 billion in the 12 months ended Sept. 30, placing its pension fund in third place on P&I's list. The board's private equity portfolio, including buyouts, earned 55.8% in the same period, outperforming its 44.29% benchmark, according to its most recent quarterly report.

Buyouts represented a large portion of the defined benefit plan's $37 billion private equity portfolio as of Sept. 30 with 35.3% in mega buyouts, 21.1% in large buyouts. 13.5% in middle-market buyouts and 1.7% in small buyouts, the report shows.

Washington ranked as the third-largest venture capital investor as well, with assets up 61.7% to $7 billion. The board's venture capital portfolio includes growth equity.

CalSTRS was second on P&I's list of top private equity investors, with assets up 63.3% to $43.7 billion.

This growth is part of the reason why CalSTRS' board ramped up its private equity target allocation by 2 percentage points to 13% last month, attaining the asset class' long-term allocation that was adopted two years ago. CalSTRS officials planned to shift to the new allocation gradually, adopting a series of interim target allocations over time, but private equity grew faster than staff expected due to "opportunities available over the last year," a staff memo said.

This led its private equity portfolio to "overshoot its target for now," CalSTRS CIO Christopher J. Ailman said at the Jan. 27 investment committee meeting. As of Dec. 31, CalSTRS had $45 billion, amounting to 13.7% of plan assets, invested in private equity.

CalSTRS is not alone in seeing its private equity portfolio exceed the target allocation, Mr. Bragar of WTW said. Asset owners around the globe are facing the decision whether to cut back their private equity investments or increase their allocations to maintain a quicker investment pace in an asset class many consider their best performer, he said.

This makes 2022 "a very relevant year" regarding potential private equity allocation changes, Mr. Bragar said.

Even those asset owners that are not overallocated are having to decide the appropriate allocations in a world in which private equity and venture capital managers are raising larger funds and leaving shorter intervals between funds in the same series, Mr. Bragar said.

These asset owners are having to make decisions about whether to retain or adjust their allocations because the rapid fundraising pace that has become the new normal could result in asset owners reaching their targets quicker, he said.

CalPERS in November adopted a new asset allocation that boosts private equity by 5 percentage points to 13%, effective July 1. As of Sept. 30, the pension fund's private equity portfolio amounted to 9.3% of total assets, exceeding its allocation target of 8% at the time.

At the same time, the private equity portfolio outperformed its benchmark by 144 basis points in the 12 months ended Sept. 30 but underperformed in all other periods.

At the investment committee's November meeting, Mr. Bienvenue attributed the one-year performance, 45.1% net IRR, of its private equity portfolio to "market dynamics that drove the benchmark, and therefore the relative performance figures." He added that "this speaks clearly to our need to take a long horizon when assessing portfolio performance, especially for private asset portfolios or for portfolios that contain private assets."

Indeed, CalPERS staff is working on ways to invest more capital in all private asset classes, including private equity, private debt and real assets. Staff is trying to "figure out a way to deploy asset at scale, while keeping our underwriting standards high" and focusing on investing more through co-investing, which has cost-saving advantages, Mr. Bienvenue said at the November meeting.

CalPERS' asset allocation also increases fixed income and real assets by 2 percentage points each to 30% and 15%, respectively. Reductions came from global equity, cut by 8 percentage points to 42%, and liquidity, down 1 percentage point to zero.

"Our investment team will continue to operate within the private markets to find accretive opportunities to increase our deployment in alignment with our new asset allocation which the board adopted in November," Mr. Bienvenue said in the statement.

CalSTRS, meanwhile, is continuing to invest in private equity through what it calls its collaborative model, which puts less emphasis on investing in commingled funds.

"The collaborative model, which has saved CalSTRS more than $780 million since 2017, is pivotal to the private equity program's strategy," spokesman Thomas Lawrence said in an email. "Co-investments are especially impactful, as they allow CalSTRS to make investments with little or no management fees or carried interest."

Indeed, at its January meeting, CalSTRS changed its private equity policy to increase delegation of investment authority to staff and ease some limits for potential co-investments. The modifications also allow staff to co-invest alongside managers not currently in its portfolio. CalSTRS has $8.4 billion in private equity co-investments.

As of June 30, CalSTRS' private equity co-investments have delivered a five-year annualized IRR of 27.1% compared with 18.9% for partnerships, a report to the investment committee showed.

At the January meeting, Scott Chan, CalSTRS deputy CIO, said the policy changes were needed to evolve its co-investment strategy to version 2.0, increasing co-investments and moving toward co-leading on them. He said that CalSTRS has built out an experienced, diverse team of private equity investment professionals, and built out its due diligence processes as well as its fiscal and operational controls to be able to execute more sophisticated co-investments.

Very large asset owners with the resources to co-invest are moving more dollars into the strategy, Willis Towers Watson's Mr. Bragar said. But it must be done with care, especially for asset owners that are near their target allocations to private equity and venture capital because co-investments increase the pace of investments, he said.

"When you put a dollar in a fund it gets invested over four or five years. A dollar in a co-investment gets invested today," Mr. Bragar said.