PGGM raises the stakes
Like some of the businesses PGGM invests in, its first step into private equity (PE) was small and unsure. Now, the giant Dutch healthworkers pension scheme is one of Europe’s largest investors and is set to become much bigger, with the proposals to run its PE assets, along with those of ABP, when the acquisition of NIB is completed.
“From 1982 to 1986, we made a modest start in PE with our first initial trial,” says Ad van den Ouweland, who is responsible for the fund’s growing portfolio of investments in this area.
From very early on internal discussions were taking place as to whether the labour intensive effort involved would be worthwhile in terms of returns, but by 1989, the fund was confident enough to commit 1% of total assets to PE.
“Our real big step forward was around 1996, when the decision was taken at board level to commit 4% of our assets,” he says. “At that time, we would have been well ahead of other players in this market in Continental Europe.” PGGM has taken that forward with the recent move to up its commitment even further to 6.5% of its $49bn (E44.5bn) assets, making the fund among the most significant of institutional participants in this asset class.
Van den Ouweland stresses the importance of regular investment. “We learned that we cannot be market timers here. If you omit some years, it is at the harvesting period of the cycle when you find you can really miss out.” But at the same time, he adds that the fund is never under pressure to make a certain amount of investment per year.
There is invariably a gap between what commitments the fund undertakes and the actual amount that is invested - in fact the fund is only 1.7% invested, despite its target of 4.5%. “We had a our big expansion in 1995-1996, but it inevitably takes some years before you can put the money to work.”
Ask van den Ouweland, what is most important when in investing in PE, and his response is that manager selection is the crucial factor. “You are entering a relationship that can be for 10 years or more and can be extremely difficult to exit from.” He should know, as PGGM have been investing through outside vehicles from 1982. The essential thing is to build up a global network of relationships, which is difficult for newcomers. Now with a $2bn portfolio, he confines his relationships to 25 partners. “Our strategy is to take big bites and not have 100 partnerships.” He points to the difficulties of just attending partnership meetings, with a small management team in-house. “Our aim is to have a limited number which we control well.”
These partners can be at the primary level, in country or regional or other vehicles, as well as funds of funds, and at the secondary level and quoted funds. The issue of doubling up that can occur with primary and fund of funds does not bother him, provided the quality is not compromised. Secondaries can fill a useful place with more mature portfolios, often at discounts.
PGGM has a strategic approach to diversifying on a geographical basis, with a benchmark for Europe of 20 to 50%, with a current 45% level of committed capital, the US, 20 to 40% ( current 30%), Far East 10 to 30% (15%), and emerging markets, 5 to 25% (10%). The fund also makes sure it spreads its PE portfolio across the different investment stages and styles, as well as industry sectors. So around 20% is venture capital with the balance split 40% to expansion capital and 40% to buy-outs. “We have good diversification by industry too.”
So has it paid off? Van den Ouweland says that in the period 1998, the net internal rate of return (IRR) achieved by PGGM averaged 14% per annum, which is a clear 4 percentage points out performance of the 10% return on the world equity index, he points out. “In my view, this is on a risk adjusted basis and is a proper return for the fund,” he says, adding that he hopes to get the IRR closer to 15%.
The fund has developed “an integration approach which has worked out very well for us”. Should a partnership have an IPO, he suggests sticking with the company rather than realising the investment. “In Europe this might be a very challenging area, staying with a company after it goes public and run with it through the cycle.”
PGGM is determined to bring more rigour to PE by developing research models. “We are studying whether PE can be a separate asset class within the fund.” Other areas are proxy benchmarking, risk model testing and the creation of synthetic long term track record for PE on a global basis. “We are also doing cash flow and fair market projection models, which show how the market will grow.”
But one of the biggest changes facing the PGGM’s PE team will be the amalgamation of its private equity activities with those of ABP and the National Investment Bank (NIB), once the two pension funds complete their acquisition of NIB. This will create not just a PE giant in Dutch terms, but in continental European terms.