Millennium hangover for Swiss
In the arena of private equity investment, Switzerland is a land of surprises. For an economy which has been largely built on the sophisticated management of other people’s money, the level of investment in private equity is lower than would be expected.
As a whole, private equity investment in 2003 was equal to 0.079% of GDP, much lower than the European average of 0.288%, according to the European Venture Capital Association’s annual survey of pan-European private equity and venture capital activity.
Part of the reason is that the Swiss private equity industry took a particularly hard battering as equity markets fell at the start of the millennium.
Several pension funds had their fingers spectacularly burnt, including the Teachers of Berne Pension Fund, which had invested large amounts in ill-fated venture capital projects, as well as directly into local companies. The press went to town on these fiascos, convincing many investors to steer clear of private equity altogether.
“Our opinion is that the disasters of the past two or three years are attributable to the way these investment programmes were implemented, and not to any problem in the asset class per se,” says Stefan Hepp, chief executive officer and founder of Strategic Capital Management, a gatekeeper working predominantly with Swiss clients.
Urs Wietlisbach, co-chairman of Partners Group, Switzerland’s largest private equity asset manager agrees: “It was mainly because of how these funds invested. Instead of using advisers, the funds chose the companies themselves. And they went into it at completely the wrong time. The problem is, all private equity gets tarred with the same brush, and a lot of smaller pension funds were frightened off. But funds like the City of Zurich started in the mid 1990s and have done it right.”
The situation was made worse by the performance of listed fund of funds – closed-ended private equity vehicles based in Switzerland. Largely set up in the late 1990s, these gave pension funds access to private equity, since otherwise government rules at the time made it difficult to invest in such a risky and illiquid asset class.
But following the stock market crash, several pension funds experienced a fairly torrid period of heavy discounts to net asset value, although these have now generally narrowed again.
“Some pension funds diversified out of listed stocks and into private equity because they thought that unquoted shares were not correlated with the public market,” says Hepp.
However, many pension funds have benefited from using private equity.
Hanspeter Bader, managing director of Unigestion, which provides funds of funds and tailored advice, says: “Some funds such as Nestlé and Baloise have a systematic approach, building up their exposure through a well-diversified portfolio of limited partnerships. Those people are pretty happy with their exposure, and many of them are redeploying the returns into further private equity programmes.”
However, with the lack of returns from other investment classes, and a more favourable climate in the press, Swiss pension funds are once again showing interest.
“We are now seeing a second wave of money going into private equity,” says Bader. “These are people who have more realistic return expectations of, say, 12-15%, instead of the 20% which people expected in the late 1990s.”
Hepp says: “There has been a resurgence in activity this year.”
According to Peter Pfister, vice president, fund of funds manager at LGT Capital Partners, it is primarily the large pension funds, managing over SFR1bn (e656m), and a portion of the medium-size funds (SFR500m-1bn) which are candidates for private equity investing. “And except for a few larger funds, they go into fund of funds,” he says.
“Ten years ago, Swiss pension funds went into private equity funds directly, or via the Anglo-Saxon funds of funds. But the Swiss market is more established now, and in the past few years, a lot of allocations have gone into Swiss-based funds of funds. Proximity is important, as the managers speak the same language. And of course, the Swiss have a long history of managing alternative investments.”
According to the European Alternative Investment Strategies Survey 2003 from JPMorgan Fleming AM, the 12 Swiss pension funds covered by the survey and investing in private equity allocated 2.1% of their portfolios to the asset class: this compares with the European average of 3.3%.
But Hepp considers that on the whole, the average allocation for Swiss pension funds is higher, and that those large funds which do invest may have 3-6% in private equity.
He reckons a typical geographical spread is just under 50% each in Europe and the US, and a couple of per cent in the rest of the world, particularly Asia. Five-25% could be in venture, with the rest in buyouts.
“Venture is being scaled down, but as a whole, there are clear signs that private equity is back on track,” says Hepp. “There has been an increase in realisations and the resulting profit, led by the large buyout funds.”
Bader adds: “Swiss pension funds have always been relatively international in their asset allocation, as the Swiss market is too narrow to achieve optimal diversification. So people tend to invest in European, US and to a lesser extent Asian equities. They are doing the same with their private equity exposure, and so the non-domestic component is bigger than the European average.”
He says that from Swiss pension funds around 80% of the money going into private equity goes into buyouts. “Over the past 18 months, there has been a huge amount of money flowing into mid-market buyout funds,” Bader says.
Bader believes that selectivity in the mid-market sector is key to performance. Even so, he says his company’s clients have outperformed public equities on the private equity portion of their portfolios largely due to relatively conservative asset allocation in buyouts, and not much technology exposure. There has also been vintage diversification within their portfolios.
Bader says: “Interest in private equity came back in late 2003 and 2004. Now there is more of a run again because equities are recovering a bit. Many funds are still not interested, but those which are target 1.5-2%, and if it works, increase exposure by a few more per cent. In future, I think we will see a split between people who don’t do private equity at all, and people who do it and raise their allocation.”
Wietlisbach says: “In the past nine months we’ve seen increased demand for private equity from Swiss pension funds. In general, they prefer to invest in Europe because it is closer to home, and European buyouts have had higher returns over the last 10 years than US buyouts. People are looking more for buyouts, and not so much for venture, since that is where several funds burnt their fingers. If they do go into venture, then they invest in the US.”