P e n s i o n C o n s u l t i n g A l l i a n c e, I n c.
Los Angeles • Portland • New York
Los Angeles Department of Water and Power Employees’ Retirement Plan
Private Equity Program Performance Report
June 30, 2007
Prepared by:
Pension Consulting Alliance, Inc.
0 P e n s i o n C o n s u l t i n g A l l i a n c e, I n c.
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Table of Contents Page
Program Overview 2
Private Equity Market Overview 3
Evolution and Current Status of the Private Equity Program 6
Investment Performance 7
Portfolio Structure 9
Summary 11
Appendix Tab A
Tracking Schedule A-1 Landmark Equity Partners XIII, LP A-2 Lexington Capital Partners VI, LP A-3
Tab B
Return Calculation Discussion B-1
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Program Overview
The Los Angeles Department of Water and Power Employees’ Retirement Plan (“WPERP” or the “Plan”) Private Equity Program consists entirely of secondary market fund-of-funds to date. The Program is very young as the initial commitments to private equity were made in 2006. As private equity partnerships are long-term investments that are invested over several years, the Program is expected to continue to grow and evolve over time.
Funding Projections The Program’s current long-term target allocation is 4% of the Plan’s total portfolio representing approximately $324 million in current market value. An evolving allocation target has been proposed where the initial private equity asset allocation target would be 1% (representing approximately $81 million in current market value) until June 30, 2008. Thereafter, the target would increase annually until reaching the long-term target. As of 6/30/07, the Program had committed $60 million across two partnerships. Funding models utilized in the 2007 Investment Strategy suggested committing up to $80 million in private equity opportunities per year over the next several years to reach the Plan’s target over a multi-year period.
Activity Summary Given near-term formation of the Program, performance to date is not very meaningful. However, both funds have been creating diversified private equity portfolios since investment activity began in 2006. Lexington Capital Partners VI (LCP VI) made its initial capital call on WPERP’s $30 million commitment in June of 2006. As of 6/30/07, LCP VI had drawn down $8.0 million in capital, distributed $1.5 million back to the Plan, and had a market value of $7.4 million. Landmark Equity Partners XIII (LEP XIII) made its initial capital call in November of 2006 and had drawn down $12.9 million in capital contributions, distributed $2.2 million back to the Plan, and had a market value of $11.9 million as of mid-year.
Portfolio Summary (as of 6/30/07) Since Peer Vintage Committed Invested Distributed Market Partnership Type Age Inception Median Year Capital Capital Capital Value 1 Net IRR IRR
Lexington VI Secondary Fund-of-Funds 2006 1.0 yrs. $30 M $8.0 M $1.5 M $7.4 M 17.0%* -10.5%
Landmark XIII Secondary Fund-of-Funds 2006 0.6 yrs. $30 M $12.9 M $2.2 M $11.9 M 23.0%* -10.5%
Total Program ------$60 M $20.9 M $3.7 M $19.3 M 20.1%* --- * investment activity is too early for meaningful results
Approximately $20.9 million (35% of the Program’s committed capital) have been invested as of June 30, 2007 and distributions have begun to be made back to the Plan ($3.7 million). Given the unique cash flows of private equity partnerships and the necessity to continually commit capital to the asset class to reach and maintain target allocations, active private equity programs never become fully invested. Therefore, continued investment activity is required for WPERP to achieve its 4% target for private equity exposure. PCA is in the due diligence process on several fund-of- funds to bring forth for WPERP’s consideration over the near-term.
1 Source: Thomson Venture Economics/NVCA, Universe of All Private Equity by vintage year. 2 P e n s i o n C o n s u l t i n g A l l i a n c e, I n c.
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Private Equity Market Overview
The U.S. private equity market continues to recover from the difficult time period after the tech bubble burst which negatively impacted the private markets by reducing investor confidence, eliminating exit opportunities, and reducing valuations. The 2007 calendar year is on pace to set a new fund raising record, exceeding the 2006 achievement of over $215 billion in commitments raised.
Commitments to All Types of Private Equity Partnerships 250
200
150
100 $ in Billions $ in
50
0
0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 6 9 0 199 199 199 199 199 199 19 199 199 199 200 20 200 200 200 200 200 D 2007 T Y Source: The Private Equity Analyst, through September
The continued record-setting amount of LBO fundraising was the big story for the first half of 2007. The last two calendar years have been the largest ever for capital raised in the LBO industry with new record fund sizes being achieved. Buyout funds were on pace to set a new record in 2007 as $108 billion had been raised in the first six months compared to $64 billion in the first half of 2006, representing a 69% increase in fund raising levels. The impact of the summer contraction in buyout financing on fund raising for the remainder of 2007 is uncertain.
Large established firms continue to dominate the fundraising. According to Private Equity Analyst, nine U.S.-based buyout firms were raising funds as of mid-year 2007 targeting capital commitments of $5 billion or more. Those nine alone have raised $105 billion to date (including amounts raised in 2006).
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After closing on approximately $215.4 billion through calendar year-end 2006, $137.2 billion in aggregate commitments were raised during the first half of 2007. Commitments of U.S. Private Equity Partnerships by Segment $250,000
$200,000
$150,000
$100,000
$50,000 Commitments (M) Commitments
$0 2006 1H 2007 LBO/Corporate Finance Venture Capital Mezzanine Fund of Funds Other Private Equity Source: The Private Equity Analyst, thru September
LBO/Corporate Finance funds continue to lead the way raising approximately 78% of the capital committed to private equity during the first six months of 2007 with venture capital funds at nearly 7%. The proportion of commitments made to venture capital partnerships is slightly below prior levels, which was approximately 16%, due in large part to the significant fund raising activities of the “mega” buyout funds.
Fund raising activities continued exhibiting strong trends in the first half of 2007 as approximately $137.2 billion was raised. This is a 70% increase from the $96.4 billion raised during the first half of 2006. 1H 07 vs 1H 06 Commitment Activity by Segment $150,000
$125,000
$100,000
$75,000
$50,000
Commitments (M) Commitments $25,000
$0 1H 2006 1H 2007 LBO/Corporate Finance Venture Capital Mezzanine Fund of Funds Other Private Equity Source: The Private Equity Analyst, thru September
Buyout funds continued their domination of fund raising statistics, with 91 funds raising $107.6 billion in commitments. Only $63.8 billion was raised by 58 partnerships during the same time period of the prior year. Venture capital funds, raised $10.0 billion in commitments, less than the $15.8 billion raised in the first half of 2006.
Fundraising activities have increased as investors have returned to the private markets and/or increased allocations after weathering the economic difficulties experienced over the past several years. In addition, exit opportunities have become more prevalent, resulting in improved performance and increased distributions to investors.
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According to the Venture Economics' U.S. Private Equity Performance Index as of 6/30/07, private equity returns have remained strong. This has resulted in an impressive 19.3% return for all private equity for the twelve months ending 6/30/07. However, the effects of earlier difficulties are still apparent in the five-year private equity return, particularly for venture capital. This five-year period captures some of the poor investment environment after the “tech bubble” burst. Buyouts significantly outperformed venture capital and outpaced the S&P 500 over this time period. Longer-term results (10-year and 20-year periods) continue to be attractive despite the poor return environment during that difficult investment environment.
Venture Economics’ US Private Equity Performance Index*, as of 6/30/07 Fund Type 1 Yr 3 Yr 5 Yr 10 Yr 20 Yr Early Stage VC 13.0% 8.0% 0.8% 39.1% 21.5% Balanced VC 21.6% 13.2% 8.0% 15.9% 14.2% Later Stage VC 22.9% 9.6% 6.5% 8.9% 13.8% All Venture 17.5% 10.2% 4.6% 19.0% 16.4% Small Buyouts 25.4% 9.1% 7.0% 4.4% 24.4% Med Buyouts 25.7% 14.5% 9.1% 10.1% 13.4% Large Buyouts 12.1% 8.9% 11.1% 7.6% 12.2% Mega Buyouts 22.1% 15.6% 12.6% 8.8% 11.9% All Buyouts 21.1% 14.1% 11.8% 8.4% 12.9% Mezzanine 15.6% 5.2% 5.0% 5.8% 8.4% All Private Equity 19.3% 13.0% 9.6% 10.7% 13.9% Source: Thomson Venture Economics/ National Venture Capital Association
*The Private Equity Performance Index is based on the latest quarterly statistics from Thomson Venture Economics’ Private Equity Performance Database analyzing the cash flows and returns for over 1860 US venture capital and private equity partnerships with a capitalization of $678 billion. Sources are financial documents and schedules from Limited Partners investors and General Partners. All returns are calculated by Thomson Venture Economics from the underlying financial cash flows. Returns are net to investors after management fees and carried interest. Buyout funds sizes are defined as following: Small: 0-250$M, Medium: 250-500$M, Large: 500-1000$M, Mega: 1,000$M+.
On an opportunity cost basis, private market returns have faired relatively well versus the public markets. Over the long-term (10-year and 20-year periods), the aggregate private equity return outperformed the domestic equity markets (as represented by the Russell 3000). While various segments of the public markets have outperformed the private markets over specific time periods (i.e. extremely strong one-year return and attractive results by international equity over recent periods), in aggregate, private market results have performed as expected providing outperformance over the long-term in addition to providing diversification benefits.
Public Market Performance, as of 6/30/07 Index 1 Yr 3 Yr 5 Yr 10 Yr 20 Yr All Private Equity 19.3% 13.0% 9.6% 10.7% 13.9% Russell 3000 20.1% 12.4% 11.5% 7.6% 10.9% Russell 2000 16.5% 13.5% 13.9% 9.1% 10.1% MSCI EAFE 27.5% 22.8% 18.2% 8.0% 7.5% LB Aggregate 6.1% 4.0% 4.5% 6.0% 7.4% Source: Investment Technologies, Thomson Venture Economics / NVCA
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Subsequent to Mid-Year 2007. However, the financial markets exhibited a “credit crunch” in the summer of 2007 which many attribute to the collapse of the sub prime home mortgage market. The syndication of these mortgages through collateralized debt and/or loan obligations purchased by hedge funds and others caused nervousness throughout the debt and equity markets. The ultimate impact of these events on the private equity markets is uncertain at the present time. Among others, a decrease in availability of credit is likely to slow merger and acquisition activity, suppress deal pricing (good for buyers, bad for sellers), and increase the number of opportunities for managers in the distressed sector.
Evolution and Current Status of the Private Equity Program
Program Evolution After adopting the Private Equity Investment Policy in December of 2005, the WPERP focused on selecting appropriate investments for inclusion in the portfolio. As discussed in the investment policy, private equity investments are expected to achieve attractive risk-adjusted returns and, by definition, possess a higher degree of risk with a higher return potential than traditional investments. Fund-of-fund vehicles, investing in both the primary market and secondary market, shall be utilized to create a diversified private equity portfolio.
Initial commitments to the Program have focused on secondary market fund-of-funds given their unique characteristics. Secondary market fund-of-funds purchase established private equity interests from existing limited partners providing several attractive benefits to investors making their initial commitments to the asset class. Benefits include: i) capital is rapidly deployed to a diversified portfolio of assets (including across prior vintage years); ii) positions are commonly purchased at a discount to net asset value; iii) risks associated with “blind pools” (a risk that is typically present in primary fund-of-funds as commitments have yet to be made to specific partnerships) is reduced as capital has already been invested; and iv) return of capital to investors is significantly accelerated as investments are made in mature holdings that are closer to achieving liquidity.
Current Status As of 6/30/07, WPERP had committed $60 million to two secondary market fund-of-funds. The Fund’s partnerships have drawn down $20.9 million in capital, distributed $3.7 million back to the Program, and had a fair market value of $19.3 million as of mid-year 2007. The near-term distributions back to the Program are representative of secondary market fund-of-funds that invest in mature private equity partnerships that are near the liquidity phase of their partnership life cycle. Distribution activity is expected to continue to increase as these secondary market fund-of-funds mature. The table below highlights the investment activities of the entire Program as of 6/30/07.
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Fund Portfolio Summary (as of 6/30/07, $ in millions)
Secondary Primary Total Portfolio Fund-of-Funds Fund-of-Funds # of Partnerships 2 --- 2 Capital Committed $60.0 M $0.0 M $60.0 M Capital Contributed $20.9 M $0.0 M $20.9 M Unfunded Commitment $39.1 M $0.0 M $39.1 M Capital Distributed $3.7 M $0.0 M $3.7 M Fair Market Value $19.3 M $0.0 M $19.3 M
Investment Performance
This section examines the Program’s performance results from a variety of viewpoints, including: since inception internal rates of return, contributions vs. market values plus distributions, and current payback.
Performance: IRR As of 6/30/07, the Program’s since inception net IRR was 20.1%. Due to the immaturity of the Program, this IRR is not very meaningful but is representative of the characteristics of initially investing in secondary market fund of funds that invest in mature holdings that can return capital relatively rapidly.
Private Equity Program Performance 30%
20.1% 20% Target Range 10% 8.6%
IRR Net 0%
-10% as of 12/31/06 as of 6/30/07 Net IRR Since Inception
The chart above represents the total Program’s net IRR at multiple points in time since the Program’s inception (June of 2006). The Program’s absolute return performance objective over the long-term is 15% net of fees internal rate of return, since inception. Therefore, current results are above long-term expectations despite the immaturity of the portfolio.
Contributions vs. Market Value plus Distributions Another way to view a program’s progress is to examine the contributions, distributions, and fair market value of a portfolio. WPERP’s program is off to a strong start as distributions to date, combined with fair market value of investments, exceed contributions. Given the nature of private market investing, it is not uncommon for contributions to exceed distributions and fair market value as investments are held at cost and management fees are assessed early in the partnership. Current results reflect the benefits of secondary market fund-of-funds that are beginning to provide near-term cash payback to the Plan.
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The following chart portrays the historical trend of these components.
Private Equity Portfolio 30.0 25.0 20.0 15.0 10.0 Millions ($) 5.0 0.0 as of as of 12/31/2006/2006 6/30/2007 31 2/ 6/30/2007 1
Contributions Ex is ting Pr iv ate Por tf olio Distributions Current Payback An additional metric that PCA examines as a measure of private market progress is the payback. This measure highlights the amount of distributions to the limited partners as a function of contributions. This measure is relatively high (at 17.7%) given the portfolio’s immaturity, but this is representative of secondary market fund-of-funds that return distributions back to investors more rapidly than tradition private equity partnerships. However, new commitments that are expected to have longer paybacks will decrease the payback as capital is drawn down.
Payback 125%
100%
75%
50%
25% 17.7% 1.5%
Cumulative Payback as % of Contibs. % of as Payback Cumulative 0.0% 0% as of 6/30/06 as of 12/31/06 as of 6/30/07 Since Inception
Total Portfolio Payback % Return of Contributed Capital (100% payback)
PPerformance Summary Across all performance measures examined, WPERP’s private equity program is generating strong results given the recent formation of the Program. As previously mentioned, the Program’s initial commitments to secondary market fund-of-funds are performing in-line with expectations.
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Portfolio Structure
This section examines the Program’s portfolio structure and diversification from a variety of viewpoints, including: number of holdings, sector exposures, vintage year diversification, the Program’s top ten holdings, and projected payback.
Holdings Diversification WPERP has committed to two secondary market fund-of-funds which are both highly diversified across partnerships and the number of underlying holdings. As of mid-year 2007, LEP XIII held interests in 124 partnerships and 1,354 underlying portfolio companies. LCP VI held interests in 122 partnerships representing more than 1,600 underlying portfolio companies.
Segment Exposures Based on reported value, the Plan’s portfolio is diversified across buyout (71%), venture capital (28%), and mezzanine (1%).
Sector Diversification
Venture 28%
Buyout 71%
Mezzanine 1%
These exposures are an aggregation of the underlying partnerships within the secondary market fund-of-funds as defined by each of the firms. Sector diversification is expected to be maintained as WPERP’s current partnerships continue to invest capital and additional primary market fund-of-funds are added to the Program.
Vintage Year Diversification In addition, the Program is diversified across vintage years. The oldest partnership’s vintage year is 1988 with meaningful exposures beginning in the 1998 vintage year due to the Plan’s commitment to secondary funds. Going forward, commitments are expected to continue to be diversified across vintage years to gain exposure to investments made at varying points of an economic cycle.
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Vintage Year Diversification
$5.0 $4.5 $4.0 $3.5 $3.0 $2.5 $2.0 $1.5 $1.0 $0.5
Reported Value (Millions) Value Reported $0.0 1988- 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 1997
Reported Value
WPERP’s commitments to Landmark XIII and Lexington VI are expected to provide additional exposure to partnerships emphasizing the vintages in the 2000 to 2003 time period. As the Program matures and evolves there are expected to be variations in vintage year exposure, but the primary goal is to gain exposure across multiple years and the Program has successfully achieved this diversification to date.
Top Ten Holdings The table below highlights the ten largest holdings in the Plan’s partnerships. These holdings are represented by investments from both LEP XIII and LCP VI and are diversified across vintage year and investment sector.
WPERP’s Ten Largest Underlying Holdings Investment Investment Year Partnership Sector Landmark Portfolio Advisors Fund II, LLC 2007 LEP XIII Diversified American Capital Equity I, LLC 2006 LCP VI Buyout Landmark Portfolio Advisors Fund I, LLC 2006 LEP XIII Diversified Saints Capital Chamonix, LP 2006 LCP VI Buyout Parish Opportunities Fund, L.P. 2007 LEP XIII Diversified ZM Private Equity Fund I, L.P. 2007 LCP VI Diversified Vision Capital Partners VI, L.P. 2006 LEP XIII Buyout Psilos Group Partners II SBIC, LP 2002 LEP XIII Venture Capital Baker Communications Fund III, LP 2000 LEP XIII Venture Capital Apax Europe IV-A 2000 LEP XIII Venture Capital
The top ten holdings represent (based upon the WPERP’s proportional share of market value) approximately 56% of the Program’s total value. However, each of these holdings are diversified investments themselves, comprised of multiple underlying partnerships and/or portfolio companies.
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Projected Payback The graph below provides an estimate of the expected payback of WPERP’s private equity portfolio. Payback is defined as distributions divided by contributions with the estimated payback representing the number of years until 100% of contributions are returned in the form of distributions. This information is represented as invested capital in the portfolio (yellow bubble on the top row) and committed capital (blue bubble on the bottom row). The size of the bubble is a function of the amount of assets for the expected payback period. As demonstrated in the chart, the portfolio is relatively concentrated in its payback structure; as commitments to date have been made to secondary market fund-of-funds which both began investing in 2006.
Estimated Payback Structure
Fair Market Value
Unfunded Commitments
012345678910
Approximate Years to Payback
The payback structure of WPERP’s private equity portfolio is expected to be diversified across multiple years as additional commitments (particularly primary market fund of funds) are made and the existing investments mature.
Portfolio Structure Summary As of June 30th 2007, approximately 35% of WPERP’s committed capital had been invested and the Program has developed a diversified portfolio of private equity investments. The secondary market commitments have provided the desired diversification benefits (including sector, manager, and particularly vintage year) to date and are expected to continue to provide these attractive exposures as the remaining commitments are drawn down and invested. These positions represent attractive core holdings that should allow the Plan to opportunistically commit capital to primary market fund-of-funds to maintain diversification across sector and vintage year.
Summary
WPERP’s decision to make initial commitments to partnerships focusing on purchasing private equity funds on the secondary market has proven beneficial as initial performance is believed to be attractive. As of 6/30/07, two commitments totaling $60 million had been made, resulting in $20.9 million in contributed capital, $3.7 million distributed back to WPERP, and $19.3 million remaining in market value. Overall, the Program has generated an attractive net since inception IRR of 20.1% as of mid-year 2007. To reach and maintain the targeted allocation level to private equity, the Program is expected to continue to commit capital on a regular basis. It is a continuous process of reviewing opportunities in the marketplace to identify appropriate candidates for the Program.
11 Los Angeles Department of Water and Power Private Equity Tracking Schedule
Date of Total Actual Total Current Fair Mkt. As of: Investment Initial Age Capital Contribution Percent Remaining Distribution Fair Market Plus Net 6/30/2007 Group Focus Investment (Years) Committed to Date Invested Contribution to Date Value Rem. Contr. IRR
New Investments Lexington Capital Partners VI Secondary Diversified Jun-06 1.0 30,000,000 8,035,708 26.8% 21,964,292 1,508,241 7,364,887 29,329,179 17.0% Landmark Equity Partners XIII Secondary Diversified Nov-06 0.6 30,000,000 12,913,393 43.0% 17,086,607 2,205,374 11,942,815 29,029,422 23.0%
Total Portfolio 60,000,000 20,949,101 34.9% 39,050,899 3,713,615 19,307,702 58,358,601 20.1% Established Portfolio** ------* commitments not finalized as of year-end ** over three years old
Alternative Inv. subtotals: Primary Fund of Funds ------Secondary Fund of Funds 60,000,000 20,949,101 34.9% 39,050,899 3,713,615 19,307,702 58,358,601
% in Primary Fund of Funds ------% in Secondary Fund of Funds 100% 100% 100% 100% 100% 100% % in Private Equity 1% 0% 0% 0% 1% Total Fund Value: $8,111,100,000 vs. Overall Target (range: 4%) 4% 4% 4% 4% 4% 4% 4%
difference in % -3% -4% -4% -4% -3% difference in $ (264,444,000) (303,494,899) (285,393,101) (305,136,298) (266,085,399)
A-1 Landmark Equity Partners XIII, L.P.
Investment Strategy Landmark XII is being formed to acquire interests in established private equity investments through secondary market transactions. The Partnership will assemble a diversified portfolio of private equity interests with the objectives of achieving superior returns at lower risk for this asset class and generating cash distributions to its partners beginning in the Partnership’s first year.
Investment Review Portfolio Profile
Current Market Value$ 11,942,815 # of partnerships: 124 Distributions$ 2,205,374 Top 10 Portfolio Investments Vintage Focus Amount Contributed$ 12,913,393 Original commitment$ 30,000,000 Landmark Acquisition Fund II, LLC 2007 Diversified Remaining to be invested $ 17,086,607 Landmark Portfolio Advisors Fund I, LLC 2006 Diversified Age of fund (in years) 0.6 Parish Opportunities Fund, LP 2007 Diversified Internal rate of return to date 23.0% Vision Capital Partners VI, LP 2006 Venture Capital Total Value Multiple 1.10X Psilos Group Partners II SBIC, LP 2002 Venture Capital Percent of capital returned 17% Baker Communications Fund II, LP 2000 Venture Capital Time to full payback (in years) not relevant Apax Europe IV-A, LP 2000 Venture Capital Baker Communications Fund I, LP 1997 Venture Capital Fund Profile Gryphon Partners III, LP 2004 Buyout LADWP Initial Investment Nov-06 Saratoga Partners IV, LP 1998 Buyout Target termination date Nov-19 General Partner Recent Activity: Landmark Partners XIII, LLC Investment strategy Secondary From inception to date, Landmark Equity Partners XIII, LP: Market Value of Partners Capital$ 482,935,414 conrtibuted $511.8 million to underlying partnerships Partners Capital in Cash$ 4,700,395 distributed $86.7 million back to investors Total capital contributed$ 511,805,993 Total capital committed$ 1,194,454,545 General Partner's contribution (% tot.) 1.0% LADWP % ownership 2.5%
Portfolio Cash Flows General Partner Compensation
Annual Mgmt. Fee: of aggregate commitments: 0.5% in year1, 0.75% in year 2, and 1.0% years 3-7 12,000,000 10,000,000 1.0% of reported value thereafter. 8,000,000 6,000,000 4,000,000 Distribution priority: 2,000,000 0 100% to LPs for primary investments Contributions Market Value Distributions After return of capital and 8% preferred return, 90% to LPs and 10% to GPs for secondaries
A-2 PCA, Inc. Lexington Capital Partners VI, L.P.
Investment Strategy Lexington VI acquires interests in established leveraged buyout, venture capital and mezzanine funds, primarily in secondary transactions. The Partnership intends to assemble a diversified portfolio of private equity partnership interests with the expectation of achieving superior returns at a well-diversified level of risk while generating cash distributions beginning in the Partnership’s first year.
Investment Review Portfolio Profile
Current Market Value$ 7,364,887 # of partnerships: 122 Distributions$ 1,508,241 Top 10 Portfolio Investments Vintage Focus Amount Contributed $ 8,035,708 Original commitment$ 30,000,000 American Capital Equity I, LLC 2006 Buyout Remaining to be invested $ 21,964,292 Saints Capital Chamonix, LP 2006 Generalist Age of fund (in years) 1.0 ZM Private Equity Fund I. LP 2007 Diversified Internal rate of return to date 17.0% Scale Venture Partners II, LP 2004 Venture Total Value Multiple 1.10X Capital Z Financial Services Fund II, LP 1998 Buyout Percent of capital returned 19% B IV Capital Partners, LP 2002 Buyout Time to full payback (in years) 4.4 Industri Kapital 2004, LP 2003 Buyout CapMan Equity VII A, LP 2002 Buyout Fund Profile KKR European Fund II 2005 International LADWP Initial Investment Jun-06 Healthcap IV, LP 2002 Venture Target termination date General Partner Recent Activity: Lexington Associates VI, LP Subsequent to quarter end, the Fund- Investment strategy Secondary distributed $30.0 million Market Value of Partners Capital$ 937,113,470 contributed $260.0 million Partners Capital in Cash$ 39,445,050 Total capital contributed$ 1,002,754,452 Total capital committed$ 3,773,870,707 General Partner's contribution (% tot.) 1.0% LADWP % ownership 0.8%
Portfolio Cash Flows General Partner Compensation
Annual Mgmt. Fee: 1.0% of commitments (0.5% of commitments to primaries) during the 12,000,000 10,000,000 investment period. 0.85% of reported value thereafter (0.5% for primaries). 8,000,000 6,000,000 4,000,000 Distribution priority: 2,000,000 0 100% to LPs for primary investments Contributions Market Value Distributions After return of capital, 90% to LPs and 10% to GPs for secondaries
A-3 PCA, Inc. PENSION CONSULTING ALLIANCE, INC.
Return Calculation Discussion
Background In the initial Private Equity Investment Policy adopted by the Board in December of 2005, the long-term (5-10 years) performance objective for the Program was the Russell 3000 Index plus a 300 basis point risk premium (reflecting the opportunity cost of investing in alternative investments versus publicly traded common stocks). The investment policy also includes a long-term absolute return performance objective of 15% net of fees internal rate of return (IRR), since inception. Subsequently in the March 21, 2007 meeting, the Board adopted a blended index (composed of the Cambridge Associates Private Equity Index at 85%, and the Cambridge Associates Venture Capital Index at 15%) as a private equity asset class benchmark. This benchmark (labeled as Cambridge U.S. PE in the quarterly report) utilizes private equity indices prepared by Cambridge Associates, LLC. Cambridge’s proprietary databases are based on return data compiled on funds representing 70% to 80% of the total dollars raised by U.S. leveraged buyout, subordinated debt, special situation, and venture capital managers between 1986 and 2006. This benchmark was chosen, in these proportions, to better reflect the overall performance of private equity investments and to better mirror market exposures.
Today, WPERP is measuring performance of its private equity portfolio with two methods. First, quarterly reports prepared for the Total Portfolio utilize the Time Weighted Return methodology to calculate performance for the private equity asset class and results are compared to the Cambridge U.S. PE index. This approach provides consistency with the method and presentation of performance results across all asset classes and for the Portfolio as a whole. Second, semi-annual private equity performance reports are prepared by PCA that primarily utilize the Internal Rate of Return (IRR) methodology to compute returns and performance is compared to the long-term 15% IRR target, among other measures (including vintage year peer comparisons once investments have matured adequately).
Introduction There are two primary methods of performance measurement employed by the investment community: Internal Rate of Return (IRR) and Time Weighted Return (TWR). The two methods vary and can be appropriate for different types of investments. The primary reason for the use of one method over the other is the effects of the timing and magnitude of cash flows into and out of a portfolio. In general, TWR is used by the investment industry to measure the performance of portfolios investing in publicly traded securities. By contrast, IRR is normally used to gauge the return of funds that invest in illiquid, non-marketable assets, such as private equity partnerships.
The difference in the nature of fund cash flows is the primary reason that investment performance may be calculated using one of the two methods. Managers of public securities funds typically can “fully invest” their portfolios over a period of several days and the timing of cash flows into and out of a portfolio is at the discretion of the investor (i.e. Plan Sponsor). Private equity partnerships, however, require several years to “fully invest” their portfolios as capital is drawn down when investment opportunities are identified and capital is distributed back to investors when portfolio companies are liquidated (commonly after a four to five year holding period).
B-1 PENSION CONSULTING ALLIANCE, INC.
Time Weighted Return TWR measures the return of an investment and does not consider the effect of investor cash moving in and out of a fund. Because of this, TWR is suitable for measuring the performance of marketable investment managers because they do not control when investor cash enters or exits their funds.
Issues of utilizing TWRs for private equity partnerships TWRs calculate a return over a specific time period (commonly a month) and then “link” these returns together to arrive at longer-term return calculations (i.e. one-year, three-year, etc.). Given the unique cash flow characteristics associated with private equity investments, interim returns calculated early on in the life cycle of a partnership can have dramatically negative return results as management fees are assessed on committed capital (a larger asset base) and applied to the market value of contributed capital (a smaller asset base as capital is drawn down over time).
In addition, underlying private equity holdings are commonly held at cost so there is no appreciation return associated with private equity investments over shorter time periods. As a result, there may be a very large negative return for an investment on a relatively small asset base that continues to be incorporated into return calculations over the life of an investment (when looking at a since inception return). IRRs remedy this situation as the calculation takes into account the timing and magnitude of cash flows over the life cycle of a partnership. The IRR may still result in a negative return early in the life cycle (i.e. the J-Curve), but over the longer-term the IRR provides a more accurate presentation of performance results.
Internal Rate of Return The CFA Institute recommends that the IRR be used to measure the return of investments in private equity securities. A major reason for this recommendation is that private equity managers typically exercise a greater degree of control over the amount and timing of their funds’ cash flows. How private equity managers exercise this control is crucial in assessing their investment skill. Thus, private equity fund managers need a return calculation method that takes into account their control over fund cash flows. By definition, IRR is the rate of return that make the value of cash flowing in to the portfolio equal to the value of cash flowing out (or market value) of the portfolio.
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