Direct investment provides instant diversification
Established in 1992, Denmark's Industriens Pension (IP) is a young scheme, and perhaps its youth explains its dynamic approach to private equity at a time when older, somewhat more established, schemes still regard the burgeonig asset class with a degree of scepticism and reserve.
But that does not mean it has gone in blindly. The €5bn private sector fund is aware of the risks and for the moment has limited overall exposure to private equity to 5%, which it hopes to achieve in the coming years by setting aside as much as €125m a year to the asset class.
"IP has developed a well-diversified first-class private equity (PE) portfolio over a relatively short period," the scheme says. "We have defined target investments by country and type."
It says this means 20% of firms it is interested in are in Denmark, 50% in the rest of Europe, 25% in the US and 5% elsewhere in the world. Buyouts will take up 60% of its allocation, with venture capital opportunities accounting for 25% and the balance earmarked for other possibilities, such as mezzanine and restructuring companies as well as those with distressed debt.
IP began investing in private equity six years ago - and has come quite far since. "IP started its private equity investments in 2000 by committing capital to three funds of funds," IP says. "This allowed us instant diversification. In addition we were tempted by a couple of local Denmark-only funds in the first years. But we realised quite rapidly that we would be better off investing directly in companies we picked ourselves for the majority of our private equity allocation."
It adds: "But we haven't abandoned funds of funds altogether. Our direct investment strategy is complemented by a limited number of holdings through specialised fund of funds vehicles that focus on specific industrial segments."
IP claims that it is this philosophy that distinguishes it from other pension funds in Europe. "Even mid-sized European pension funds have outsourced the fund selection to either consultants or funds of funds," it says. "IP regards fund and manager selection to be a key competence of the organisation and has always focused on building skills internally within these areas."
Young and adventurous or not, IP's attitude towards private equity is not the result of a whim but a carefully planned strategy that is based on several factors.
First, IP believes its approach is more cost efficient since its yearly commitments of €125m over five years to reach the desired 5% limit would be more than €5m in yearly fees if it continued to invest in private equity through funds of funds.
Next, IP argues that investing directly will enable it to build up its knowledge and understanding of private equity. It says this has given it the confidence to extend the range of investments from low-risk segments characterised by European mezzanine and global secondary funds.
Finally, investing directly gives IP greater control over the segments it invests in. This means it can reduce or decrease its allocations as it has active control over risk budgets.
"An additional benefit from the strategy has been that the knowledge and skills gained from selecting private equity investments have been beneficial in our investments in other asset classes, such as real estate and infrastructure," it adds.
IP says that before it adopted its new strategy it met a large number of primary funds, funds of funds and consultants. One of the key findings from the meetings was that the vast majority of the investments they make are in brand name private equity funds with a long track record. Both the consultants and the funds of funds argued that the funds they had invested in were difficult to gain access to.
But IP rejects this notion. "Many of these funds had already contacted IP on own their initiative or made themselves available if we approached them," the scheme points out. "Therefore, we did not pay much attention to the access argument and concluded that the fund did not need external assistance for most of its private equity investments."
The result? IP has adopted a proactive strategy and visits all the funds it considers attractive within a segment. This means its two full-time private equity employees have seen more than 400 private equity funds. Currently, the scheme invests in 28 funds.
Finally, IP stresses the importance of not just looking at funds which are in fundraising phase but at those about to start their next fundraising. Access to oversubscribed funds is not generally a problem. However, it continues to use external help with venture capital since the disparity between the best and worst performing funds remains huge.
Highlights and achievements
Rare is the pension fund that embraces radical change and sets the standard for others to follow. But by being proactive rather than reactive to fresh investment ideas, Denmark's IP has shown that investing in private equity can be done with skill and efficiency. Its streamlined and strategic approach - diversifiying geographically as well as by segment - proves private equity can be a great return generator and not an asset class to be feared.
Youth may be on its side, but the way the scheme has stood up to be counted rejecting the advice of its consultants and seeking a path for itself in private equity shows pension schemes are ready to challenge advisers to ensure the best returns for their members.