Europe plays catch-up with US
European pension funds’ commitment to alternative investment (AI) looks set to mirror that of US institutions, with strategic allocations raised to reflect strong growth, according to the recent report by Goldman Sachs and Frank Russell on alternative investing by corporate and public pension funds, endowments and foundations.
The 1996–99 survey, the first to include results from Europe and Australia, shows over 60% of the 61 European respondents already investing in alternative assets.
Average strategic allocation by European funds as a percentage of assets has been ratcheted up from 1.9% in 1996 to 2.5% in 1999 (see Figure 1), with three quarters of commitments split between venture capital and leveraged buy-out (LBO) funds. General private equity portions invested come out at 13.9%, with mezzanine financing bracketed at 2.3%. And fund predictions are that the overall average strategic allocation will rise to 2.9% by 2001.
Expectations are that over the next three years venture capital positions are likely to be boosted to over half of European AI portfolios due to the rapid pace of technological change.
LBOs will also remain popular at just over a third of the AI assets with funds citing the healthy backdrop of the convergence in euro markets.
General private equity portions though are predicted to fall to around 1.5%, while mezzanine financing will quadruple to over 8%.
Total European assets invested by the respondents in AI represent e13.4bn, of which e6.4bn is invested, says the report. Significantly, almost three quarters of the investment over the two-year period was made through new managers.
Europe does not reflect the US on all AI aspects, however. While over three quarters of alternative commitments have been to limited partnerships, the survey reveals that Europeans tend to use more fund of funds vehicles than their US counterparts.
Furthermore, European AI investment is also more geographically diversified.
Western Europe accounts for an average 59% of European AI portfolios with 35.1% invested in the US and 5.2% in Asia. By comparison US funds now place almost 90% of their AI allocation in the domestic market.
Notably, a breakdown between the UK and continental Europe shows mainland investors with much greater exposure to the US (51.8%) and Asia (8.8%). UK pension funds still keep over three quarters of their AI exposure in western Europe, placing just under 15% stateside.
Over three-fifths of European respondents comment that they use consultants or gatekeepers to advise on research, strategy and monitoring for their AI forays.
John Taylor, managing director in the pension services group at Goldman Sachs, comments: “The survey indicates that alternative investments by Europeans is likely to move in the same direction as North America.”
There is still some way to go, however. During the same period, average allocations to alternative assets by US corporate and public funds rose from 6.3% to 7.3%. Actual dollar commitment to AI by the 189 US respondents represents $152bn.
Hal Strong, managing director at Frank Russell Capital, comments: “The survey shows this trend should continue. US respondents expect their strategic allocation to alternative investments to rise over the next three years from an average of 7.3% to 8%.”
LBOs continue to account for the majority of the commitments by tax-exempt organisations in the US at 46% of average allocation, followed by venture capital and international private equity at just over 18% apiece. The total commitment to international investment now also stands at around 14% on average, against 9.3% in 1997.
However, US respondents concur with European funds that venture capital will be the most attractive asset class of the next three years.
In terms of the geographical trend for AI investment by US institutions – Europe has caught the eye.
Western Europe shows the biggest regional dollar increase by US funds – up $9.7bn (14.5%) from 1997, although eastern Europe appears to be the hot spot recording the highest percentage leap up 187.7% on the same period.
The survey also includes figures on US fund shifts into ‘opportunistic real estate’ – defined as real estate investment through commingled funds. Under half said they allocated to these funds with relatively small strategic levels. Returns for the survey period averaged 15.7% with expected figures slightly below this for the next three years.
And only one in 10 US funds say they invest in hedge funds, with respondents noting a lack of congruency between hedge fund risk/return profiles and plan investment objectives, as well as the lack of hedge fund disclosure and transparency.
The US alternative tide is undoubtedly being swelled by healthy performance figures. Survey participants recorded actual venture capital returns peaking at 33.5% between 1996-1998 and average returns rolling out at 24.7%.
Future forecasts to 2001 offer return figures of 22% for venture capital, 20% in LBO funds and 15% in mezzanine financing.
However, almost 90% of replies stated their primary concern for the next three years would be chasing a limited number of attractive deals with their excess cash.