Texas’ largest public pension fund has decided to shift nearly $10 billion from private equity investments, a setback for an asset class that has come under increasing scrutiny amid falling yields and a slowdown in portfolio company exits.

The move by the Teacher Retirement System of Texas, which manages $202 billion in assets, is a fresh setback for an industry struggling to close deals and raise funds after a long era of easy profits.

Texas Teachers is the second of the largest public pension funds to officially reduce its target allocation to private equity, cutting it from 14% to 12% — below the 13% average for all U.S. public pension funds, pension officials said at a board meeting Thursday.

The pension fund estimates it will report a 9.3% return for its latest fiscal year, Chief Investment Officer Jase Auby said at the meeting. That compares with a 3.85% return for the previous fiscal year and will beat an annual return target of 7%.

At the end of March, the fund had $33.7 billion in private equity investments, or 16.7% of its portfolio, meaning it was already over-allocated to the asset class. Cutting that exposure to 12% would mean removing about $9.7 billion of private equity investments from the portfolio.

The pension has no plans to sell private equity investments to the secondary market to reach the lowered target, Neil Randall, managing director of private equity at Texas Teachers, said at the board meeting. The pension is no longer writing checks to large buyout funds, instead focusing on smaller funds in the middle market.

Alaska Permanent Fund, which manages the state’s $80 billion sovereign wealth fund, began reducing its commitments to private equity in 2022, lowering its target from 19% to 15% the following year. CIO Marcus Frampton said at the time that private equity needed a reset and that he wanted to be cautious. Earlier this year, the Alaska fund opted to lean back into the asset class, raising its target to 18%.

Texas Teachers’ decision to divest from private equity and move that money into public equities was based on expectations of continued pressure on returns from investments in the asset class. The pension fund said it will begin the cut in October and that it will take several years to achieve.

Not only

Many U.S. public pension funds have recently increased their private equity allocations, in part because their existing exposures already exceed previous targets. Three of the largest have raised their targets this year, including California Public Employees’ Retirement System, California State Teachers’ Retirement System and the New York City pension funds.

Pension funds, chronically underfunded, are trying to balance their investment decisions with the need to meet future payment promises to thousands of public sector workers. The Texas fund has only 77.5% of the assets it needs to pay future obligations.

That means private equity firms may continue to struggle to find interested investors for future flagship funds. Texas Teachers isn’t alone in grappling with how to stretch fewer dollars. Others are doing so by slowing their pace, or how much money they invest each year.

Still others, such as Colorado’s Public Employees’ Retirement Association, or Pera, have used secondary funds to actively manage their private equity portfolios. Pension funds are allocating more to those funds than in the past, opting to exit some new fundraising and also looking to strategically sell their existing holdings in private equity funds to free up liquidity.

“It hasn’t been the case in the past that LPs were actively managing their private assets,” Amy McGarrity, Pera’s chief investment officer, said in an interview. “With delayed exits and excess capital that hasn’t been called, and the desire to get exposure to future vintages, there’s a sense that maybe there needs to be some more active management.”

Investors like to invest in secondary funds because they can buy vintage investments that they would otherwise have missed out on, and they can get their money back faster than with a new fund.

– Marion Halftermeyer for Bloomberg