In Depth February 18, 2010, 5:00PM EST

The Pension Fund Beating Private Equity

The Ontario Teachers' Pension Fund is doing an end run around private equity—and racking up better returns

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Leech holds assets for the long term, keeping the fund competitive with private equity K.C. Armstrong

By Jason Kelly

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Even as the economy slid into the recession, Jim Leech was making private equity deals. In 2008 he picked up a Chilean utility. Last year he bought a $211 million stake in U.K.'s Bristol International Airport. Now Leech is making a hostile bid for Australian toll-road operator Transurban Group, offering $6.2 billion. If consummated, the deal will be the largest buyout since the credit markets collapsed nearly three years ago.

There are a couple of reasons Leech never had to step away from the negotiating table. He doesn't have to rely on borrowed money, and he doesn't have to court investors. He has plenty—almost 300,000, in fact. They are the teachers of the Canadian province of Ontario, and as CEO of their $83 billion pension fund, Leech is charged with protecting their retirements. That sets him apart from rival dealmakers at Kohlberg Kravis & Roberts (KFN), Blackstone (BX), and Carlyle Group.

Most public pension funds, such as California Public Employees' Retirement System (CalPERS), have outside money managers pick their investments. The Ontario Teachers' Pension Plan does much of its private equity investing directly. It has bought or picked up stakes in almost 300 companies over the past two decades. Simmons Bedding, the General Nutrition Centers vitamin chain, and the Toronto Maple Leafs hockey team all belong in part to the educators of Ontario. The teachers paid cash for Aquilex Holdings, an industrial cleaning company, just weeks after the fall of Lehman Brothers in late 2008. "Even when other private equity firms were on the sidelines, we were there," says Leech.

Leech's strategy of keeping leverage in check and holding assets for the long haul has kept the fund competitive with the big boys of private equity. Since its inception in 1990, Ontario Teachers' private equity arm has earned 19.6% a year, in line with top firms. In 2008 the private equity group lost 13%, vs. nearly twice that for the average buyout fund. (Some 40% of its private equity assets are managed by outside investment firms, including many of the same ones it teams up with to make deals.) Ontario Teachers', which also holds stocks, bonds, real estate, and other alternative assets, made a bad bet on fixed income in 2008 and was down 18%. That made it the fund's worst year, but it still topped CalPERS, which lost 26%.

Ontario Teachers' success may eventually change the shape of private equity investing. Other pension funds are beginning to invest on their own. Ontario Teachers' partner on the Trans-urban deal is the Canada Pension Plan Investment Board. "We operate more like Goldman Sachs Asset Management" than a pension fund, says Mark Wiseman, who left Ontario Teachers' to help Canada Pension Plan develop a private equity strategy. Dutch civil service pension fund ABP owns a portfolio of companies, including Imagem Music Group, the music publisher. Australian pension funds are buying up bridges, toll roads, and other infrastructure.

"A CLEANER STRUCTURE"

Direct investment may also become more attractive to pension funds in the U.S., where state and federal authorities are investigating relationships between big pension funds and their outside money managers. Private investment firms paid at least $125 million to middlemen to help win lucrative contracts from CalPERS, according to a report by the pension fund. "The motivations to go direct are higher than they've ever been," says Colin Blaydon, director of the Center for Private Equity & Entrepreneurship at Dartmouth College's Tuck School of Business. "It's a much cleaner structure with less potential for conflicts." Says CalPERS spokesman Brad Pacheco: "CalPERS has acted quickly, adopting a strict policy to require disclosure about placement fees and sponsoring a bill that would end contingency fee arrangements."

Ontario Teachers' began dabbling in private equity in 1990, just one year after KKR's landmark leveraged buyout of RJR Nabisco.