CalSTRS distressed debt, mezzanine portfolios disappoint

The $161.5bn retirement system’s distressed debt and mezzanine portfolios failed to clear three and five year performance benchmarks, which contributed to a disappointing returns for the private equity programme. 

Lacklustre performance within The California State Teachers’ Retirement System’s mezzanine and distressed debt portfolios has contributed to its private equity programme falling short of three and five year performance benchmarks, according to a Pension Consulting Alliance report made available through CalSTRS’ website.

CalSTRS’ private equity programme, which includes allocations to distressed debt and mezzanine funds, generated a five-year return of only 3.9 percent as of 30 September, well short of the 6.5 percent custom benchmark set by the $161.5 billion retirement system.

The private equity programme’s failure to meet its benchmarks was due in part to disappointing returns from its mezzanine and distressed debt holdings. Mezzanine generated a 5.6 percent five-year return, falling 410 basis points less than its 9.7 percent target. Distressed debt generated a 7.5 percent five-year return on an 8.7 percent target.  

“Distressed debt, representing 13 percent of the [programme]’s market value, has increased in size due to commitment activity to this sector since 2007, which opportunistically positioned the portfolio,” according to the report. However, “partnership selection and commitment timing have dampened returns, as material amount of the distressed debt commitments were funded prior to the economic crisis.”

Approximately 53 percent of CalSTRS’ distressed debt commitments went to pre-crisis 2007-2008 vintages, according to the report. The retirement system has remained active in the strategy over the last two years, committing $630 million to 2011 and 2012 distressed vintages that include Ares Corporate Opportunities Fund IV, GSO Capital Solutions Fund II and TPG Credit Strategies Fund II.

That being said, the outlook on the distressed debt vehicles remains mixed.

“Interest in the leveraged loan market pushed the price of leveraged loans back towards par after lows seen in 2009, easing the opportunity set for trading strategies,” according to the report. “However, pricing volatility over the past couple of years has provided trading opportunities.”

As of 30 September, approximately 13.2 percent ($4 billion) of the private equity portfolio was exposed to distressed debt strategies, which the retirement system broadly defines as senior-secured debt investments in troubled or bankrupt companies.

The private equity programme’s mezzanine portfolio is considerably smaller than its holdings in distressed debt. Total exposure to mezzanine was reported at $589 million, or 1.9 percent of the private equity programme’s total exposure, according to documents.  

The retirement system’s $50.8 billion private equity portfolio also fell short on a three-year basis, returning only 13.4 percent compared to the 16.6 percent generated by its custom benchmark and the 14 percent by the State Street Private Equity Fund Index.

“Strong since-inception results for the European buyout, venture capital, expansion capital and mezzanine sectors have contributed to longer-term outperformance, while underperformance of the US buyout sector, distressed debt and mezzanine sectors has dampened results over the latest three-year period,” according to the report.

CalSTRS did not respond to a request for comment at press time.