In some quarters, private equity is seen as a haven of tranquillity in the equities marketplace. For some, it is a quiet investment niche where fund managers can go back to basics – assessing the prospects for a business which has yet to set sail on the turbulent seas of the financial markets.
But there are other views. Some pension fund trustees are getting cold feet about equity investment altogether. So have Europe’s pension fund managers changed their attitude to private equity?
The City of Zurich pension fund has held private equity investments since 1998, and is still in the process of building up its portfolio. It holds these investments as a way of diversifying its equity holdings, and therefore spreading the risk, a spokeswoman says.
And within the investment type, the holdings are diversified too. “We’re trying to spread between venture and buyout, and the holdings are mostly European and US,” she says. The investments are made through funds of funds.
So far, the City of Zurich pension fund is only about halfway towards its goal of holding 5% of its entire portfolio in private equity investments. It will take about four years until the fund is fully invested in the sector, the spokeswoman says.
The Wacker pension fund in Germany made its first foray into private equity in 2001. The proportion is still small compared to the fund’s entire portfolio, with less than one per cent of total assets in private equity.
But the entry into the sector has been slower than anticipated. To a certain extent, says Markus Taubert, head of portfolio management at Wacker, the weak condition of equity markets in general has been a discouraging factor.
“Generally, our positive long-term view towards PE has not changed, but we will reduce our investment speed in these days as we do not expect to miss opportunities if we don't invest into new funds now,” he says.
On the other hand, low market valuations are a good opportunity for buying into the private sector, he says. Compared to historical cycles valuations are bottoming out. But still, says Taubert, the attractive investment environment will remain as it is for the next 12 months.
Other pension funds agree that fragile conditions in the broad stock markets do have a real impact on the private equity sector. “It matters a lot when they’re trying to sell on the stockmarket as an IPO – it is directly linked,” says one pension fund official.
The most important considerations when investing in private equity, says Taubert, are strong outperformance against traditional asset classes and portfolio diversification.
There are some pension funds in Europe that have set their sights on private equity, but have yet to dip their toes in. They are still going through the formal decision-making process.
Silvio Vecchi, managing director of the E1.9bn pension fund of the European Patent Office, says his fund is currently thinking about moving some of its capital into private equity. “We are considering it. It’s a decision that doesn’t depend on us but on the supervisory board,” he says.
The fund’s management team will create a proposal in favour of private equity investment, which will then be put before the supervisors.
In common with many pension fund managers, Vecchi takes the view that poor conditions in the mainstream equity markets encourage rather than discourage moves into private equity. After all, private equity is a way of diversifying investments, he says.
Approval for the investment move will hopefully be given in the next few months, he says. When management gets the go-ahead, the pension fund will take the fund of funds route for its private equity involvement, says Vecchi, rather than considering investing in private companies at an individual level.
A priority will be to keep as diversified as possible within the private equity sector, he says.
Industry participants say the slump in global equity markets over the last three years has enhanced valuations in the private equity market.
The Railways Pension Scheme in the UK has invested in private equity for more than 10 years. It runs pension funds for the employers and employees of the privatised railway companies, and one of those is a private equity pooled fund.
Until about three years ago, says Peter Murray, CEO of Rail Pen, about 1.5% of total assets were in private equity. “Then the trustee decided it would recommend they increase the weighting to 5% and also diversify – up to then we had been in UK large buyouts only,” he says.
Since then, the fund has diversified both by sector and geographically, he says. The only sensible strategy to adopt in private equity is to have a portfolio diversified by entry stage, sector and vintage year, he says. Favouring a particular sector makes no sense in private equity because of the long-term horizon the whole investment type is based on.
“Just because a particular sector is in difficulties now doesn’t mean that it’ll be having trouble in five or ten years time,” he says.
Murray agrees these are good times to be investing in private equity. “The current conditions in the private equity market have provided us with an opportunity to invest in good value private equity propositions,” he says
“An investment now isn’t going to be realised for five to 10 years. You’d expect the market to be well out (of the doldrums) by then,” he says.
And anyway, private equity is not the type of investment one can switch easily in and out of. The market is not very liquid and selling prematurely can be expensive, says Murray. “We don’t think we get the best value by moving in an out,” he says. “You get it by deciding on a strategy and then sticking to it.”
Danish pension fund ATP aims to build up its private equity allocation until it reaches a target of 10% of the overall portfolio. It set up a business dedicated to private equity investment in order to achieve this. The business – ATP Private Equity Partners – is run by Jens Bisgaard-Frantzen.
ATP Private Equity Partners now has a fund of funds vehicle – Fund 1 – where the pension fund is the limited partner and the management is the general partner. This gives a big incentive to the management team and assures the pension fund that the managers are not taking excessive risk, says Bisgaard-Frantzen.
He says investing in private equity has become a more interesting activity, in the current broad market environment, because there is less competition for the good funds.
It is a good time to be coming into the market, he says, because many of the limited partners of earlier projects have burned their fingers. This means there are more opportunities left for those who enter now.
“Because the IPO market has been nearly closed for some time, there's not so much liquidity coming back to the limited partners, so they're not reinvesting,” says Bisgaard-Frantzen.
In 1998 to 2000, there was a lot of investment in venture capital funds. But fundraising volumes have decreased dramatically since then, and the amount of liquidity coming into the private equity market is, by contrast, limited. This has led to good opportunities, he says.
“The key is still to stay diversified. We’re looking for a good manager, consistency in execution of strategy, and we want coherence of the investment team. They should demonstrate the ability to add value through financial and operational skills,” he says.