Bloomberg News

Blackstone’s Biggest Investment Shows Clients’ Clout

December 09, 2011

(Corrects Grady’s quotes in fourth and fifth paragraphs, and clarifies that the management fee is on invested capital in 11th paragraph of story published Dec. 8.)

Dec. 8 (Bloomberg) -- Blackstone Group LP won as much as $1.8 billion in state pension money from New Jersey, the most an investor has committed to the firm at one time since it opened its first buyout fund in 1987. Its client won lower fees.

The state will put up to $1.5 billion into four new custom funds called separately managed accounts, according to terms approved today by the New Jersey State Investment Council. The remaining $300 million will go to three existing funds run by Blackstone, the world’s biggest private-equity firm.

Big private-equity investors are turning to separately managed accounts, or SMAs, to obtain cheaper fees and more control in exchange for locking up their money for a decade or more. Last month, the Teacher Retirement System of Texas committed $3 billion apiece to KKR & Co. and Apollo Global Management LLC.

The deal with New York-based Blackstone will save New Jersey about $120 million in fees over the life of the agreement and “enable us to be more nimble, more flexible, but still take advantage of a terrific partnership with a world-class organization,” said Robert E. Grady, chairman of the New Jersey Investment Council, which approved the commitments at a public meeting today in Trenton.

“It allows us to take advantage of Blackstone’s feet on the street,” Grady said in an interview.

Blackstone is New Jersey’s largest alternative-asset manager, the investment division said today. The state pledged $2.5 billion to the firm in the past 12 months, according to a report by the council.

Separate Accounts

Under the agreement, as much as $1 billion will go to two separate accounts focused on buyouts and real assets. The rest will be allotted to custom energy and credit funds run by GSO Capital Partners, Blackstone’s credit-investment unit, with the total not exceeding $1.5 billion.

New Jersey also will invest in three funds open to the firm’s other clients: $150 million in Blackstone Energy Partners I, $100 million in GSO Special Situations and $50 million in Blackstone Capital Partners VI.

The New Jersey Division of Investment oversaw $69.6 billion as of Oct. 31, including the assets of seven retirement systems providing benefits for more than 780,000 current and future retirees.

The investment council voted 7-2 to approve the commitment.

Under the agreement, Blackstone will receive 1 percent of the invested separately managed cash annually as a management fee and an average of 15 percent of the profits from successful investments, according to a report by the council. That’s lower than the industry’s traditional “2 and 20” structure that pays a 2 percent management fee and 20 percent of profits, a fee known as carry.

‘Cowboy Investing’

Blackstone will collect a carry of 20 percent and management fees ranging from 0.75 percent to 1.5 percent from the three open funds.

James Marketti, a council member representing the Communications Workers of America labor union, opposed the deal.

“I call this cowboy investing and I’m not sure as institutional investors that we should be in this kind of program,” Marketti said at today’s hearing before the vote. He called the deal “an effort to circumvent the responsibilities” of the investment council.

Grady, the chairman, said the agreement will allow council members to opt out of any investment “that they don’t think is appropriate for the state or doesn’t reflect their values at any given moment or that they don’t think is a good opportunity.”

Texas-KKR Deal

The way the biggest private-equity firms are courting investors represents a shift that began when the global market plunge of 2008 slowed fundraising. Now institutions such as Texas Teachers, which oversees $107 billion, can bargain for lower management fees and greater investment options.

The Texas pension cash that went to KKR and Apollo will be placed in separate accounts at each firm, and the pension system will share ideas with the buyout managers. Texas Teachers agreed to allow the firms to reinvest a portion of Texas’s profits back into the funds. KKR took almost a year to agree to the terms of the commitment.

Blackstone passed on the fundraising deal with Texas Teachers because “it didn’t make much sense” for the firm’s plans, Chief Executive Officer Stephen Schwarzman said last week.

“Groups like Texas and others are flexing their purchasing-power muscle,” said Brian Birk, managing partner at Sun Mountain Capital, a Santa Fe, New Mexico-based firm that helps institutions such as pension plans invest in private equity. “There is a lot of concern in the LP community that GPs are making a very nice living off of fees, so this type of structure is a better way of aligning interests.”

TPG, Carlyle

LPs, or limited partners, are the pensions, endowments and other investors in funds run by general partners, known as GPs.

TPG Capital and Carlyle Group are among private-equity firms that have either set up separate accounts or are in the process of doing so.

For buyout funds with at least $2.5 billion that are gathering money now or that completed fundraising in 2010 and 2011, the average management fee is 1.58 percent, according to London-based researcher Preqin Ltd. While reduced fees from separately managed accounts may erode profits at private-equity firms, they may have little choice if forgoing SMAs means losing business to competitors.

“It’s unclear whether these large LPs would give money to GPs if they didn’t offer separate accounts,” said Steven Nadel, a partner in the investment management group at Seward & Kissel LLP in New York. “It’s kind of like having a choice between making money and paying taxes or not making money.”

--With assistance from Elise Young in Trenton and Cristina Alesci in New York. Editors: Josh Friedman, Larry Edelman

To contact the reporters on this story: Devin Banerjee in New York at dbanerjee2@bloomberg.net; Sabrina Willmer in New York at swillmer2@bloomberg.net

To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net


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