The €560m Nordurlands Lifeyrissjodur is a pan-industry private pension fund for employees in Iceland’s Northern Province. Its 12,000 members include workers in the fishing and manufacturing industries, as well as the service sectors. The hybrid scheme is biased towards the defined contribution model, although it is obliged to pay a certain minimum pension.
About 50% of the fund is invested in domestic bonds, mainly government issues, but also some corporate paper. The rest is largely made up of listed domestic and foreign equities, and foreign fixed income. There is a small allocation to hedge funds.
The fund started investing in private equity just over two years ago.
“We decided to start investing for diversification, as well as trying to enhance our equity returns,” says Kari Arnor Karason, the fund’s managing director. “Furthermore, although the asset class is more illiquid than public equities, it is also, relatively speaking, less volatile because the investment horizon is usually much longer.”
There is also another reason for the fund’s private equity strategy.
“We think that it is a growing market, especially in Europe,” says Karason. “It is an immature market, and less well researched than the public markets, which are fairly efficient.
So there is much more scope for outperformance.”
Around 1-1.5% of the pension fund portfolio is invested in private equity, all of it via funds of funds. The investments cover different private equity categories, with the bulk in buyouts in Europe and the US, across different segments – small, mid-market and larger scale buyouts. There are also some investments in US venture and mezzanine.
The managers include LGT, Standard Life, Merrill Lynch, Schroders and Adveq.
The pension fund has been investing each year, with cash starting to be drawn down.
So far, the investments have not returned any money but the notional returns have mostly been what was expected, says Karason.
“We’re still in the J-curve and we won’t see any positive return for another two or three years,” he says. “We expect to make 3-5% more than public equities.”
Karason and his colleagues have learned several lessons about running a private equity portfolio.
“It is very different from investing in public equities,” Karason says. “Information is not readily available as with public equities, so more due diligence is required, and that is more time-consuming. We have studied a lot of private equity groups – and there are a lot.”
He does not advise that pension funds cut corners on research. “I would recommend that people take their time. There is a lot of marketing going on and you have to be sure that what you invest in is what suits you. I would recommend that you get in consultants or have a structure to put into place.”
He says pension funds need to work out how they are going to diversify within the private equity world, and how they are going to use expertise to help them find the right managers and to do the proper due diligence.
A key to all this is networking, and Karason suggests in particular making contact with pension funds that have already gone down the private equity route.
As for the future of his fund’s private equity portfolio, he says: “We have fairly high hopes and expect to expand it to around 20-25% of our foreign equity exposure. We expect foreign equities to make up 20-25% of our fund, so that would be between 5% and 8% of the total fund.”
Once again, the watchword is patience. “We know it will take time, but we are not in a hurry,” says Karason. “The pace will depend on finding suitable investment opportunities. We have defined our goals and where we want to go, so whether it takes another two or five years is not important. But we expect to be there in about five years’ time, if everything goes according to plan.”