University of California to double PE allocation by 2020

University of California Board of Regents is planning to curb its endowment’s exposure to public equity and fixed income and to increase its target allocations to private equity and real assets by 2020, in expectation of a more challenging environment for public markets.

At its 14 March board meeting the $9.9 billion endowment approved an increase in private equity target allocation to 22.5 percent from 11.5 percent. It also increased its real asset target allocation, which now includes real estate, to 12.5 percent from 3 percent. The target allocation for real estate was previously set at 7.5 percent.

The move toward private equity comes after the endowment’s active use of the secondaries market to dispose of stakes. It had sold about $1.7 billion in 100 private equity fund stakes in a 30-month period to September 2015 in an effort to cut down its number of manager relationships, as reported by Secondaries Investor.

“What that’s translated into is our ability to be more proactive with our key relationships and to mine opportunities in a more precise way,” said Edmond Fong, managing director of absolute-return investments.

This expansion will come at the expense of the endowment’s public equity portfolio, which will be reduced from the current allocation of 42.5 percent in 2017 to a target of 30 percent in 2020, according to meeting materials.

“Clearly stock markets globally are highly valued, and we’ve continued to see a rally and significant earnings growth,” said Scott Chan, senior managing director for public equity, during the meeting.

“The potential of interest rates rising will increase the discount rate and affect stock values, and finally there’s a number of geopolitical risks.”

Chief investment officer Jagdeep Singh Bachher noted the single largest way for the endowment to be cost-efficient is by cutting down its exposure to active public equity managers, which could reduce investment costs by as much as 20 basis points. The team plans on focusing more heavily on passive managers instead, while remaining with high performing active managers.

An internal report found that the endowment is not something the University of California schools rely heavily on for their operating budgets, meaning the cashflow required from the Board of Regents is relatively low compared with its endowment peers.

“That’s very important because that allows us to have a very long-term view,” Samuel Kunz, the endowment’s managing director of asset allocation and investment strategy, said at last week’s meeting. “We are able to take advantage of the illiquidity premium and increase our allocation to private equity because of our long-term view, which will be mostly funded by public equity.”

Bachher noted that the shift toward a greater allocation to private equity will be done gradually based on opportunities.

“This isn’t causing an itch for us that we have to be invested this way tomorrow,” he said. “If private equity is fairly or highly valued, and just because we have a target set at ‘X’, and we just fill a box, that’s also not appropriate because we have to live with that for a decade. There are good opportunities from time to time, and when we see those, we will take out of the public markets and put it into private.”

The endowment’s private equity portfolio produced an annual return of 20.8 percent as of 31 December, compared with a public equity portfolio performance of 4.4 percent for the same period, according to other 14 March meeting materials.

Overall, the endowment generated a 6 percent return. It was unclear whether the returns were net or gross of fees.