Harvard Case - Illinois Teachers' Retirement System, 2019: Private Equity Performance
"Illinois Teachers' Retirement System, 2019: Private Equity Performance" Harvard business case study is written by Susan Chaplinsky. It deals with the challenges in the field of Finance. The case study is 17 page(s) long and it was first published on : Jul 6, 2020
At Fern Fort University, we recommend that the Illinois Teachers' Retirement System (ITRS) adopt a more strategic approach to private equity investment, focusing on improving risk management, enhancing portfolio diversification, and optimizing returns. This recommendation involves a multi-pronged strategy that includes:
- Refining the Investment Strategy: ITRS should develop a comprehensive and transparent investment strategy that clearly defines its private equity objectives, risk tolerance, and performance benchmarks.
- Strengthening Due Diligence: ITRS should enhance its due diligence process for private equity investments, focusing on rigorous analysis of fund managers' track records, investment strategies, and alignment of interests.
- Improving Portfolio Allocation: ITRS should strategically allocate its private equity investments across various sectors, geographies, and investment stages to optimize risk-adjusted returns and achieve diversification benefits.
- Implementing Robust Monitoring and Reporting: ITRS should establish a robust system for monitoring and reporting on private equity investments, including regular performance reviews, risk assessments, and communication with fund managers.
2. Background
The Illinois Teachers' Retirement System (ITRS) is a public pension fund responsible for managing the retirement savings of over 400,000 Illinois teachers. In 2019, ITRS faced a growing challenge in achieving its investment objectives, particularly in the private equity asset class. The case study highlights the concerns surrounding ITRS's private equity performance, including underperformance relative to benchmarks, lack of transparency in fund manager selection, and limited risk management practices.
The main protagonists of the case study are the ITRS board members and investment staff, who are tasked with making critical decisions about the allocation of pension fund assets. The case study also highlights the perspectives of various stakeholders, including teachers, taxpayers, and investment professionals.
3. Analysis of the Case Study
The case study reveals several key issues that require attention:
Financial Analysis:
- Underperformance: ITRS's private equity portfolio has underperformed its benchmarks, raising concerns about the effectiveness of its investment strategy and fund manager selection.
- Lack of Transparency: The lack of transparency in the selection and performance evaluation of private equity fund managers raises concerns about accountability and potential conflicts of interest.
- Limited Risk Management: ITRS's limited risk management practices expose the pension fund to potential financial losses and volatility.
Strategic Analysis:
- Lack of a Defined Strategy: ITRS lacks a clear and comprehensive private equity investment strategy, which hampers its ability to make consistent and informed investment decisions.
- Limited Portfolio Diversification: ITRS's private equity portfolio lacks sufficient diversification across sectors, geographies, and investment stages, exposing it to concentrated risk.
- Insufficient Monitoring and Reporting: ITRS's monitoring and reporting systems for private equity investments are inadequate, hindering its ability to track performance, identify potential issues, and make timely adjustments.
Operational Analysis:
- Inefficient Due Diligence: ITRS's due diligence process for private equity investments is not sufficiently rigorous, leading to potential investments in underperforming or risky funds.
- Limited Communication with Fund Managers: ITRS's limited communication with fund managers hinders its ability to effectively monitor investments, understand fund performance, and address potential concerns.
4. Recommendations
To address the challenges highlighted in the case study, ITRS should implement the following recommendations:
1. Refine the Investment Strategy:
- Develop a comprehensive and transparent private equity investment strategy that clearly defines ITRS's objectives, risk tolerance, and performance benchmarks.
- Establish a clear framework for fund manager selection based on rigorous criteria, including track record, investment strategy, alignment of interests, and fee structure.
- Implement a systematic approach to portfolio allocation, ensuring diversification across sectors, geographies, and investment stages.
- Establish a clear process for monitoring and reporting on private equity investments, including regular performance reviews, risk assessments, and communication with fund managers.
2. Strengthen Due Diligence:
- Enhance the due diligence process for private equity investments, focusing on rigorous analysis of fund managers' track records, investment strategies, and alignment of interests.
- Conduct thorough due diligence on individual investments within the private equity portfolio, evaluating the underlying businesses, market conditions, and potential risks.
- Employ external experts, such as independent consultants or specialized due diligence firms, to assist in the due diligence process.
3. Improve Portfolio Allocation:
- Diversify the private equity portfolio across various sectors, geographies, and investment stages to optimize risk-adjusted returns and achieve diversification benefits.
- Consider investing in private equity funds with different investment strategies, such as growth equity, buyout funds, and venture capital.
- Explore opportunities in emerging markets to enhance portfolio diversification and potentially achieve higher returns.
4. Implement Robust Monitoring and Reporting:
- Establish a robust system for monitoring and reporting on private equity investments, including regular performance reviews, risk assessments, and communication with fund managers.
- Develop a comprehensive reporting framework that provides clear and concise information on portfolio performance, risk exposures, and fund manager activity.
- Implement a system for tracking and managing key performance indicators (KPIs) related to private equity investments.
5. Basis of Recommendations
These recommendations are based on a thorough analysis of the case study and consideration of the following factors:
- Core Competencies and Consistency with Mission: The recommendations align with ITRS's core mission of providing secure and sustainable retirement benefits for its members. By improving private equity performance, ITRS can enhance the long-term financial health of the pension fund.
- External Customers and Internal Clients: The recommendations aim to satisfy the needs of both external customers (teachers and taxpayers) and internal clients (ITRS board members and investment staff). By improving transparency and accountability, ITRS can build trust and confidence among all stakeholders.
- Competitors: The recommendations consider best practices in the industry, benchmarking ITRS's performance against other public pension funds and private equity investors. By adopting a more strategic approach, ITRS can compete effectively in the increasingly competitive private equity market.
- Attractiveness - Quantitative Measures: The recommendations are expected to improve ITRS's private equity performance, leading to higher returns, reduced risk, and enhanced long-term value creation for the pension fund.
6. Conclusion
By implementing these recommendations, ITRS can significantly improve its private equity performance, enhance risk management, and achieve its investment objectives. A more strategic approach to private equity investment will enable ITRS to build a more robust and resilient portfolio, ensuring the long-term financial security of its members.
7. Discussion
Alternative approaches to private equity investment include:
- Passive Investing: ITRS could consider investing in publicly traded private equity funds or exchange-traded funds (ETFs) to achieve diversification and lower management fees. However, this approach may limit ITRS's ability to influence fund manager decisions and potentially reduce returns.
- Direct Investing: ITRS could choose to invest directly in private companies, bypassing private equity funds altogether. This approach offers greater control and potential for higher returns but also involves higher risk and requires significant expertise.
The key risks associated with these recommendations include:
- Implementation Challenges: Implementing these recommendations requires significant effort and resources, including staff training, system upgrades, and potential changes to existing processes.
- Market Volatility: Private equity investments are subject to market volatility and economic cycles, which can impact performance and potentially lead to losses.
- Fund Manager Selection: Selecting the right fund managers is crucial for success, but it can be challenging to identify and evaluate their performance and track record.
8. Next Steps
To implement these recommendations, ITRS should:
- Form a Task Force: Establish a task force composed of board members, investment staff, and external experts to oversee the implementation of the recommendations.
- Develop a Timeline: Create a detailed timeline with key milestones for each recommendation, including due diligence, investment selection, portfolio allocation, and monitoring and reporting.
- Allocate Resources: Secure the necessary resources, including budget, staff, and technology, to support the implementation of the recommendations.
- Monitor Progress: Regularly monitor the progress of implementation and make adjustments as needed to ensure the recommendations are effectively implemented and achieving the desired outcomes.
By taking these steps, ITRS can transform its private equity investment strategy, enhancing its performance, managing risk, and ensuring the long-term financial security of its members.
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Case Description
Cinda Klickna, trustee of the State of Illinois Teachers' Retirement System (TRS), was preparing to vote in June 2019 on a proposed $75 million investment in a new fund being raised by First Light Capital (FLC), a midsized buyout firm. Illinois had been under financial pressure for some time, and TRS, the state's largest public pension, was seriously underfunded. In 2012, TRS's board began a plan to strategically increase its allocations to private equity (PE). By 2018, the target allocation to PE had reached 15%, well above the 10% average of other public pensions. The increase in PE was undertaken in an attempt to close the funding gap necessitated by insufficient state funding and the generally low-interest-rate environment. The strategy had not gone unnoticed, and many now openly questioned the higher risk and costs of these investments. In the face of this greater scrutiny, Klickna believed it was important that the pension's PE investments earn a satisfactory return, by looking to invest in funds that had upper-quartile returns and public market equivalents (PMEs) greater than one. This case is appropriate for courses that cover PE investments, such as those typically covering topics on venture capital or PE, or courses on asset management that include alternative assets. It introduces students to some of the commonly used PE performance metrics and the challenges associated with measuring performance for an illiquid asset class. Students are introduced to the Global Investment Performance Standards (GIPS) and their purposes and limitations in evaluating performance. Students are asked to calculate the gross and net since-inception internal rate of return (SI-IRR), DPI, RVPI, TVPI, and PME for the same pending investment in FLC Fund IV and compare how performance is assessed across these metrics. The case also discusses the push for greater disclosure in the PE industry as it grows in its influence and public investors seek to know more about its performance.
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