Climbing on the bandwagon
Total investment in private equity in the UK has continued to rise during 2000, although local investors may still be missing out on the profitability of the sector.
The British government has been taking steps to lead pension funds into private equity investment. In a 1999 speech, prime minister Tony Blair famously called upon pension funds to open their eyes and their pockets to venture capital. Subsequently, a review of pension fund regulation by Gartmore chairman Paul Myners seems to indicate that a relaxation of current regulations is likely, which will ease the way for pension funds to get into private equity.
But even before any steps are taken following Myners’ review, the feeling in the industry is that interest in private equity on the part of pension funds is definitely rising. “I would certainly say that the level of interest from pension funds has gone up dramatically,” says George Anson, managing director of HarbourVest Partners.
“In the private equity and fund of funds world, the big, experienced groups have been trying to meet with consultants but we have been told that they did not want to meet with us, that such meetings would be a waste of time because they had not seen any interest from their pension fund clients,” Anson says.
He maintains that Tony Blair’s speech inspired a total reversal. “It is partly sentiment-driven. There is no motivation on the part of balanced fund managers to invest in private equity because they do not get paid for the risk,” he says. “What has moved along is government pressure. There is a clear implication that if pension funds do not start investing in venture capital, the government may have to legislate for it, to move the economy along.”
Now the business environment is totally different. “After shunning us, consultants are suddenly begging us to meet with them. They are even putting us forward to bid for mandates. Its great for us and unprecedented.”
Whatever the cause of the UK pension fund’s newfound positive outlook, it cannot come too soon. In 1999, 69% of the funds raised by members of the British Venture Capital Association (BVCA) were sourced from foreign investors. In fact, overseas pension funds invested three times the amount invested by UK pension funds; in 1999, UK pension funds recorded a decrease in venture capital investment over the previous year. However, despite the lack of investment by pension funds, 1999 was a record year for venture capital investment and 2000 looked like it continued the trend.
Ian Armitage, managing director at Mercury Private Equity, has also seen increased interest from institutional investors, particularly pension funds. He notes that the larger funds have increased their exposure significantly over the past year. But he questions the impact that Tony Blair’s speech had: “Who takes advice from a politician about business?”
Rather, he attributes the growth in interest and investment to the “demonstration effect”, maintaining that institutional investors have been able to see that over the long term, private equity investment offers excellent returns without significantly increased risk.
There are now documented 10-year returns, showing the results of private equity investment over an entire economic cycle. “Over the long term, private equity investment is only a little more volatile that the FTSE 100,” he says. “On the level of individual investment, there is more risk in private equity than in a publicly traded company but in a diversified portfolio there is risk mitigation”. Also pension fund trustees are getting to know the companies in which venture capital is invested, by serving on their boards and by hearing and seeing their success stories. Patrick Cook, director of 3i Funds Management, agrees. “The figures speak for themselves,” he says. “Investors have seen the spectacular gains made by industry players like 3i and the US venture capital houses.” He noted in particular an enormous increase in early-stage venture investment, an area in which institutional funders have been relatively less interested in the recent past.
According to figures from Initiative Europe, of 1,154 private equity-backed deals between July 1999 and December 2000 in the UK, involving £35.9bn (e41bn), 289 were early-stage deals, amounting to £1.3bn; 362 were buyouts, amounting to £28.3bn, and 502 were growth capital, amounting to £6.3bn. Certainly returns, as well as new investment, have been extraordinary over the recent past. There are some signs of a slowdown.
Anson also stressed the importance of taking a long-term approach to private equity investment. “It is one of those asset classes where you have to be patient, to invest over time, to feed money gradually into the marketplace,” he says. “But institutions have now seen the light. They are using advisers specialists and not trying to do it themselves.”
The final conclusion of Myners’ review is yet to be seen, but it has already has a positive effect, in that it has further raised the profile of venture capital investment. The venture capital industry has so far responded favourably, with the BVCA releasing a statement welcoming the preliminary findings. The outlook from individual practitioners remains positive yet cautious.
“I hope that trustees and pension fund managers explore the option of private equity investing as a serious means to raise returns in their funds, To the extent that this report helps, it is an excellent contribution,” says Cook. “But I would not like to see a more coercive approach. It would be ironic from an industry with capitalism in its title to seek state coercion to develop the industry.”
Mercury’s Armitage was similarly measured in his response. “The review has raised the profile of private equity, and the answers it appears to be coming up with are suitable and pragmatic no compulsion but removing technical obstacles.” But he added: “the pensions industry in this country is good, and respected internationally. If it ain’t broke, don’t fix it, don’t add a lot of regulation.”
The recent growth in the Irish private equity market has gone hand in hand with the astounding progress of the economy. Venture capital has funded the high-tech companies that are driving economic growth.
The Irish economy is still the fast-growing in the OECD, and the high-tech sector is a major driver of the economy. There are around 700 indigenous technology and software companies, with more than 100 start-ups annually. “We have a strong, vibrant economy, with a strong indigenous technology sector, particularly on the back of a growth in venture capital investment,” explains Conor O’Connor of Enterprise Equity Ireland. “As a result there are better opportunities for promoters to raise capital. His firm, based in Dundalk, offers a revolving fund focusing on the north of Ireland and border companies in the south.
“Although growth is not sustainable at this pace, rapid development will continue for around three more years,” says Niall Carroll, managing director of ACT Venture Capital. “There has been an adjustment but the upward trend will carry on, and venture capital firms will be more careful. There are still a lot of opportunities.”
Carroll reckons that private equity investment in Ireland in 2000 was up around 40 to 50% on 1999. ACT is beginning in March to raise funds for its latest fund, ACT 2001. it will have a strong focus on technology, with 80 to 90% of funds raised invested in the sector, and around 90% invested in Ireland.
Venture capital has contributed greatly to the growth of the technology sector, and thus to the economy as a whole. Government agency Enterprise Ireland (this agency is not connected with the private firm, Enterprise Equity Ireland), the state organisation charged with developing indigenous Irish industry, recognised early on that private equity funding would be crucial and encouraged investment . Pension funds have been eager investors into Irish venture capital funds.
In 1999, pension funds put in Ir£63m (e80m) into venture capital investments, according to the Irish Venture Capital Association, against Ir£6m from banks and
Ir£1 m from corporate investors: only banks exceeded that total, with Ir£70 m invested.
Although they are more eager investors, ACT’s Carroll believes that the Irish pension funds are less sophisticated in their approach to private equity than are their British counterparts. Although their way was smoothed by a favourable regulatory environment early on, Irish institutional investors need no incentives to invest into private equity beyond the established level of returns on offer. “I do not think any arm twisting is necessary,” saysO’Connor. “Success breeds success.”
In fact, the results generated by Irish private equity investment have attracted foreign investors, and both O’Connor and Carroll have noted increased interest from funds outside of Ireland. While there is no fund of funds focusing on Irish venture capital, Irish funds do play their part in many international venture capital funds of funds.