Chicago Teachers' Pension Fund Identifies Good (& Bad) Trends In Today’s PE, VC Market | Andrew Kelsen, Portfolio Manager | Q&A
Andrew Kelsen was named on Trusted Insight's 2018 Top 30 Private Equity, Venture Capital Investors. This interview has been edited and condensed.
Trusted Insight: You joined the Chicago Teachers’ Pension Fund in 2014. What did the portfolio look like and how has it evolved since you joined?
Andrew Kelsen: CTPF was founded in 1895, making it one of the oldest public plans in the United States. When I joined, there was a clear direction to decrease the number of managers and fees paid across the plan. We also aimed to increase diversity, raise conviction and improve the quality of our returns.
CTPF started investing in private equity back in 1996. From 1996 through 2014, 85 percent of our capital commitments went to fund-of-funds, with the balance going to our Minority and Woman-Owned Business (MWDBE) portfolio.
We re-underwrote the entire portfolio, and at the same time, we tried to become a little more self-aware. Understanding where there were opportunities to prosecute the board's objectives, knowing where we have the talent and the bandwidth to make primary fund commitments and where we need an intermediary. We know that we have enough scale to move away from the traditional off-the-shelf fund of fund model, but we also don't want to change the end products we invest in. How funds get in our portfolio is what really matters.
We've begun making primary buyout and growth allocations, and we have also increased our efforts in MWDBE, which is predominantly U.S. lower middle market. The long-term goal is to raise the MWDBE portion and the direct primary commitments to a minimum of 25-30 percent of the PE portfolio each. We know we are always going to need an intermediary for certain spaces like venture capital, co-investments and secondaries.
Trusted Insight: How do you analyze a PE/VC fund? What key quantitative metrics and qualitative elements are most important to you and your investment committee?
Andrew Kelsen: I am a former trader and consultant, so analysis follows two tracks. Qualitatively, we really think it's wise to use our time up front and make sure that we're investing in the right people. The general partner’s belief system needs to line up with how we think. Things like character, integrity, diversity, cultural fit and portfolio fit are really important.
"Artificial intelligence and machine learning are things that I hope do not have the same effect on private equity that algorithms and automation have had in public markets... They are no longer markets but bazaars."
Quantitatively, we like to think about general partners' entire track records. We don't rely on micro-slicing and say, "They do really well in X environment." We like to take everything that they’ve done since inception. Good markets and bad markets. There are two things we look for: persistent out-performance of global public markets and low loss ratios. These will drive multiples and we think in terms of multiples and PME’s versus IRR.
Trusted Insight: What are the most common reasons for a deal in the PE/VC asset classes not getting past your investment committee?
Andrew Kelsen: As a public pension plan in Illinois governed by the Illinois Pension Code, hiring managers is a transparent, public RFP process. We run old fashion RFPs. We define the search; we ask for qualifications, certifications and use the ILPA Due Diligence Questionnaire. If you don't follow our initial procurement process, that is a problem. It's really simple. You'd be surprised how many people choose to submit the things they want to submit. It's on our website, “you have to be registered, you need to certify a few local things and thoroughly complete the ILPA DDQ. If you can't follow instructions and fill out a questionnaire, we are going to have a difficult time trusting you with $10 to $100 million for the next 15 years.
Post RFP, after the Board has made selections, we begin contracting. Everyone is hired “pending successful completion of contracting.” We will read and have an opinion on every single sentence in your LPA. We don't view LPAs as a formality or a check the box form. It is a rigid partnership agreement and we will read every single sentence of it.
Trusted Insight: How do you see machine learning and artificial intelligence playing a role in today’s institutional PE/VC investment world?
Andrew Kelsen: Artificial intelligence and machine learning are things that I hope do not have the same effect on private equity that algorithms and automation have had in public markets. What happened in the public equity markets, and beginning now in public fixed-income markets, has radically changed the structure of our capital markets. They are no longer markets but bazaars. For the first time probably in history, we've created tools that are smarter than we are. I hope they remain tools, and we don't become the tools.
"On the technology side, I really like the whole CRISPR, targeted therapies and gene editing themes. We mapped the genome 10 to 20 years ago, and now the technology has finally caught up and we're on the threshold of being able to do some really special things."
We need to be careful. Some very forward-thinking people have spoken about the idea of singularity. I don't underestimate that. Machine learning and AI are great novel things. They will fundamentally change the future. Venture capital and private equity will point the money hose and talent at this and there will be big winners, but there will be big losers. Just like Facebook and other social media, there is also the other side of the story, the trade-offs. I think with machine learning, robotics and artificial intelligence, there is the potential for huge swaths of jobs to be replaced, including portfolio managers, reporters, truck drivers and others up and down the job market. I just think we need to be a little careful about this. Technology is awesome. We just need to be careful how it is applied.
Trusted Insight: What trends are you seeing in today’s PE/VC market?
Andrew Kelsen: I see both good and bad trends.
In terms of good trends, fees and terms are ever so slowly starting to move in the LP's direction. Large GPs know what their investors want, and management fees and waterfalls are slowly changing. Another good trend we are seeing is orderly succession at some older GPs. Good firms have been very thoughtful in growing the next generation of managers. Some firms are on the third and fourth iteration of post-founders. This is a good thing for LPs like me who like to underwrite more than one fund with a manager. We want to invest with GPs for multiple fund cycles, not just one investment. Data standardization is slowly happening, and that's being driven a lot by ILPA and their DDQs and reporting templates. We are in a very robust secondary market. LPs like me have lots of old-line items that we're looking to sell into this market and we have an evolving kit of tools to use for portfolio management. On a social level, there’s a growing awareness of ESG.
On the not so great side, we are starting to see more and more credit provider’s language showing up in the LPA. That is a very different kind of language than most private equity people are used to. I think there is a persistent lack of diversity at general partners and service providers. You open a pitch book for most general partners and it's 20-30 guys that look like me. There might be a woman or two in IR or legal, but industry-wide, there is a serious lack of gender and ethnic diversity among the middle and upper investment professionals ranks. There is no simple quick fix, but it can and should change.
Trusted Insight: We are nine years into a bull market, valuations are high and interest rates are low. There is a lot of capital in markets today, both private and public. How do you see the PE/VC market performing over the next 5-10 years?
Andrew Kelsen: Five to ten years is a really long time. I'm not sure what I'm going to have for lunch tomorrow. There are some certainties that we can all count on. There are always going to be more private companies than public companies. There will always be entrepreneurs starting new companies, there will always be business owners that want to grow their business and there will always be innovators and scientists that have a stream of new ideas and technologies. What I also believe is that, in the long run, private markets will outperform public markets persistently. The degree of that delta will change over time. The general shape of it stays the same, private lays on top of public which lays on top of debt, very consistent over time.
Trusted Insight: What industry or vertical in the PE/VC space are you most interested in right now?
Andrew Kelsen: Inefficient spaces exist in capital markets, and there are investors out there who are experienced and have track records of exploiting those inefficiencies. I tend to like less crowded trades. A space like transportation, logistics and distribution is always interesting to me. It's just one of those boring, core, grinder spaces that there are always lots of things to do in. Another one is natural resources. Energy, forestry, agribusiness, mining and hard assets are huge spaces, but there are little niche areas where there are structural inefficiencies and there are people who know how to exploit it. Growth markets are evolving. Asia and Africa are extremely interesting, but they have been interesting for decades. Execution and partner selection is the key.
On the technology side, I really like the whole CRISPR, targeted therapies and gene editing themes. We mapped the genome 10 to 20 years ago, and now the technology has finally caught up and we're on the threshold of being able to do some really special things.
Trusted Insight: What differentiates your investment strategy from that of your peers? What are some key similarities and differences?
Andrew Kelsen: We are a large public plan that has been investing in private equity and venture capital for a long time, primarily through fund-to-funds. However, we're not alone in the idea that we want to slowly evolve from that purely intermediated model. There are more than one or two plans out there that have grown their staff, built good teams and have moved to more of a direct primary fund model. We've got great fund-to-fund partners and we will continue to use them, but it is all about understanding where we should use them and what they're good at. Not everybody is good at everything. Identifying what people are good at and moving forward is a big difference between us and some of our peers.
One of the big differentiators here is the diversity of our team. It's a really diverse team from different backgrounds, education, work experiences, age, nationality, ethnicity and demographics. We all bring something different to the table and it makes for a really great investment team and work environment.
Trusted Insight: Is there anything that you would like to add about yourself, Chicago Teachers’ Pension Fund or private equity investing broadly?
Andrew Kelsen: From my point of view, there is always room for improvement. We are 128 years old and we are laser-focused on improving how we do business. Public pension plans have very unique challenges and advantages. This is public service. It starts with hiring and retaining the right people. Next, a strong, strategic asset allocation is the dominant determinant of portfolio risk and return. You need good governance and efficient communication between the Board, Management, the CIO and the investment team. You have to drive exceptional manager selection. We exist for one reason and that is to pay benefits to retired public school teachers. At the end of the day, we have 63,000 bosses and they expect no less from us.
View our full catalog of interviews with here.
The complete list of Top 30 Private Equity, Venture Capital Investors can be found here.