Growing familiar with PE's face
Investing in private equity can allow pension funds to reap big rewards, though most European funds still keep away from this alternative asset class. Investment performance can be hard to monitor until maturity, and the structures often required – such as limited partnerships – can cause headaches from a regulatory point of view.
However, many funds have dipped their toes into private equity and have plans to boost their allocation over the next few years.
The Suez-Tractebel pension fund in Belgium has had some private equity investment since 1997, although this first investment was only for a small amount, says Olivier Poswick, head of portfolio management at the fund.
In 2002, the fund then increased the private equity allocation to 1% of total assets under management. Then, in 2003, it set a new strategic asset allocation based on traditional asset classes, with private equity integrated within the equity portfolio with a weighting of 5% of total assets. The pension fund manages a total of E1.3bn in assets.
Poswick says the fund decided to invest in private equity partly for diversification within the equity portfolio, partly for the expected returns, but also because it believes that private equity investments give the fund a better understanding of the equity markets.
The majority of the private equity portfolio at Suez-Tractebel is invested in funds of funds – all except for 18%, which is invested in direct private equity funds. The reason the fund took the funds of funds route, is because it provide greater diversification. Manager selection is more critical than it is with traditional equity markets, it says.
But the fund acknowledges that it does not have enough skills and means in-house to select and follow a lot of direct funds.
In terms of manager selection, Suez-Tractebel gives preference to boutiques. Poswick gives many reasons for keeping it small. One of the main risks in private equity investment is having too much money and not enough good deals. Also, the largest asset managers are, he says, too heavily orientated towards marketing; they are out to maximise fees on a short-term basis, and this can cause a conflict of interest with the investors.
No investment banks were selected, he says, because the fund believes that the ‘Chinese wall’ does not work. One of the managers chosen is not a boutique but, in this case, his institutional investors’ commitment is a good guarantee, says Poswick.
Before the pension fund increases its current allocation to private equity, some remaining problems have still to be ironed out, he says. There is the problem of liquidity for mature pension funds, and also the question of benchmarking. There are some anomalies in the benchmarking data. An investment horizon of at least five years is required before having any relevant information from the benchmark.
On top of this, the fund needs to see the impact of the new IAS accounting standards on the volatility, and it needs to get a better view on the private equity managers’ ability to raise new assets.
The Strathclyde Pension Fund in Glasgow has invested in private equity as an asset class for quite a number of years, says David Crum, chief pensions officer (investments).
“SPF appointed Pantheon as
the Fund's PE portfolio manager back in 1990,” he says. “Their initial remit was to manage 2.5% of pension fund assets in private equity.” Like Suez-Tractebel, the Strathclyde fund has opted to invest in PE through the fund of funds approach.
There are no plans to increase the current allocation, which stands at 5% of the total fund. It was increased to this level in 2003.
Crum says the benefits for the fund in holding private equity as part of its overall asset mix are primarily the risk diversifying characteristics of the asset class, and also the investment return profile.
While seeing these benefits, the fund also harbours some concerns about private equity. “The main current concern that we have about investing in private equity is the flows of new money into this asset class,” says Crum. “This may possibly make it harder for the manager to locate suitable investment proposals in the future as demand soaks up supply.”
Apart from this, the Strathclyde fund has, he says, the ‘usual’ concerns over issues such as valuation, transparency, liquidity and benchmarking. “But we have become comfortable with these over time,” he says. “The industry has also done much to address these issues.”
Overall, though, Crum is satisfied with the way the asset class is managed. “We are happy with the private equity industry, and have full confidence in the way Pantheon invests fund assets on our behalf,” he says.
Pension fund Industriens Pensionsforsikring in Denmark has around 2% of assets invested in private equity. It has had exposure to private equity since the end of 2000, and plans to increase the allocation in the future. The fund’s long-term private equity target allocation is 5%, says Jan Østergaard, chief investment officer. Five percent seems reasonable, he says, with regard to the expected risk/reward for the asset class.
Østergaard cites the main benefits for IPF of holding private equity as the risk diversification it provides, and the improved expected return/risk.
Silvio Vecchi, managing director of the European Patent Office
pension fund, says the fund is still considering moving some of its assets into private equity. “We have made a proposal for possible
alternatives to the asset allocation,” he says. “The supervisory board is now considering it.”
The proposal contains several alternatives, and private equity is among them. Vecchi says he has
no particular concerns about investing in private equity in
principle, but he notes that
investing in private equity is
more complicated than putting money into quoted securities. “Also, there are a lot of regulatory implications,” he says.
The structure of private equity investments can often be a stumbling block. “Very often, if you want to invest in private equity, you have to enter into a limited partnership,” he says. And this has regulatory implications for pension funds.
Theoretically, if mutual funds of private equities were available in the market, this would make it much easier to invest, he says.
The Wacker Chemie pension
fund in Germany made its first investments in private equity in 1998. It has found it had to wait longer than expected for returns. “We stayed in the typical J-curve for about two more years than
originally expected,” says
Markus Taubert, head of portfolio management at the Wacker fund.
This was due mainly to market conditions, he says. “Multiples went down not only for public companies but also private ones,” he says.
But despite the fact that its returns from private equity are lagging to a certain degree, the fund is still pleased with the two fund of fund managers it is working with in the asset class. “We are pleased with their process and their access…We realise that a lot of the time performance lags is due to market deterioration rather than difficulties with the single primary fund they’ve selected,” he says. “We have a clear positive view towards the asset class itself.”
If there is any improvement the private equity industry could perhaps bring about, it would be to soften the J-curve dip investors go through at the initial stage of investment. This could involve adding well-priced secondary investments into the fund mix, Taubert suggests. “So that the first start-up costs are not as deep,” he says.