Back in those halcyon days when hopes for even the smallest internet start-ups were high, many institutional investors felt they could not afford to ignore the private equity market. The rewards for getting in early seemed unmissable. Venture capital managers argued – and it was true at the time – by the time a young technology company was launched on the stockmarket, enthusiasm was at fever pitch and the initial offer price had rocketed.
Since then though, the technology sector has had a sobering two years. The bubble burst in spring 2000, and the whole sector has suffered a series of knocks in the period since then.
Pension funds, however, invest in equities for the long-term. But has their confidence in the private equity market been undermined by the experience of seeing many small companies going to the wall?
“Our attitude has not changed at all towards private equity,” says Jens Bisgaard-Frantzen, from ATP. A year and a half ago, ATP decided to up its private equity asset allocation to 10%. “This means we now have one of the largest private equity allocations in terms of percentage compared to other European institutions,” he says.
As a consequence of that asset allocation decision, ATP opted to set up a separate business dedicated to private equity investment. It now has an ATP fund of funds managed by a legally separate company, which is still in the process of being set up. In the next four years, ATP will commit E4.5bn to the new business, says Bisgaard-Frantzen.
Far from being put off by past losses in the private equity market, ATP says now is a good time to plough money into pre-quoted companies. “We consider the current environment to be very favourable for the roll out of this programme,” he says.
No one is expecting instant returns, of course. “I don’t think it’s too risky, because we are anticipating making exits in three to four years’ time,” he says. He compares the next few years to the early 1990s, which have turned out to be vintage years for the private equity market.
And venture capital managers have learnt a lot from the collapses seen since the millennium. “I think venture capital investment managers are getting more realistic in terms of prices and structure, and in terms of the time to market,” says Bisgaard-Frantzen. “Two years ago, it was no problem getting financing for companies with no earnings or sales, but now venture capital companies are more demanding.”
He predicts a contraction in the number of venture capital companies out there. A number will bite the dust, he says, which will leave only the higher quality ones at large.
Dutch pension fund giant PGGM has also effectively spun off its private equity investment arm. The private equity mandate is now in the hands of NIB Capital, which also manages private equity investment for Dutch the biggest pension fund ABP.
Investing in private companies is still a key part of PGGM’s strategy. “Our view on private equity has not changed,” says Ellen Habermehl of PGGM. “The whole fact that last year was not a great year for investors has nothing to do with our view of private equity.”
The pension fund sees the poor fortunes of private equity as part of the general market weakness. “We knew that after many good years we could expect bad years – also in this asset category,” says Habermehl.
PGGM currently holds 7.5% of its assets, which total around E52bn – in private equity. “We will not change that. We are sticking to the ALM studies we did before,” she says. Back in 1994, PGGM held just 4% of assets in private equity.
Private equity investment gives PGGM the chance to boost overall capital growth. “If a (private) company does very well, the results are extremely good compared to public companies,” she says.
But despite the potential returns trumpeted by venture capital managers, many pension funds steer clear of private equity altogether. Others dip no more than their toes in. Gino Pfister, pension fund director of Swiss corporate fund Novartis Pensions Kasse says the investment guidelines approved by the board of trustees allows investments in private equity up to a maximum of 5% of total assets.
“We have however never exceeded the mark of 2%,” he says. “The reason is that over an eight-year period we were not able to exceed with private equity investments those returns achieved by us with investments in large caps.”
Pfister says Novartis has become convinced that – in any field – it is impossible to exceed benchmarks consistently unless the people making the investment decisions have clearly above average competence. “We have also experienced that this expertise can be achieved only in a limited field of possible investments,” he says.
“Our most valuable expertise lies in managing large cap bottom up investments and management of hard currencies. Selecting successful private equity managers has not been one of our top competencies. In addition we value liquidity highly,” he says.
Novartis’ limited and shrinking investment in private equity has not been
influenced by recent developments in the market, he says. To achieve the required returns at a risk it can afford, a fund has to be geographically diversified and invested in bonds and equity, he says. But that doesn’t mean it has to be invested in all possible asset categories.
Dominique Salamin, pension fund manager of state social security fund AVS in Geneva, says his fund has not a single private equity investment at the moment. But it is not against private equity investment per se. “Private equity is an important asset class, which can’t be ignored, since its risk/reward characteristics are very different from other asset classes,” he says. “It therefore makes a lot of sense to include private equity in a portfolio for diversification and return enhancement.”
Some mature pension funds in the UK have been put off private equity by an experience which dates back much further than the millennium. The investment manager of one large UK pension fund explains why his fund now steers clear of private equity altogether.
“In the 1970s we invested in a venture capital fund inspired by the Bank of England, called ‘Equity Capital for Industry’,” he says. “Of course, it was a disaster, and our trustees have taken a jaundiced view of private equity ever since.”
Even if the trustees did have more confidence in the potential returns of private companies, there are other reasons to stay out of the market from an investor’s perspective, he says. “Liquidity is important, and the fees levelled are pretty atrocious.”
Some investors may consider now to be a good time to be putting money into pre-quoted companies, but this investment manager believes it is still too early. “My view is that there is still too much money chasing too few projects,” he says.
At the end of 1999 and the start of 2000, returns from private equity were very inviting. But those returns have since gone into reverse because the exit market for private companies has collapsed. And there is still a vast amount of investment capital waiting to find a home, he says.