Picking winners and losers
The Swiss institutional investor market is very heterogeneous and the level of sophistication of its participants varies greatly. Historically, Swiss pension funds have had a lot of capital to invest as they are required to be fully funded. As a rule, the vast majority of pension funds prefer to invest in private equity via funds of funds and Switzerland is no exception.
By investing in these vehicles, institutional investors seek to spread their risk and learn about the industry before making any direct investments. The main advantage of fund-of-funds over single funds is vintage year diversification. Funds of funds have proven popular with the smaller Swiss pension funds which often lack the internal capability to invest directly in private equity funds as the selection process demands time, energy and considerable investment.
The first institutional investors began to look at the Swiss private equity market at the beginning of the 1990s, gaining strong bargaining power and market influence with the private equity houses. But the majority of investors jumped into the asset class at the end of the decade when they made their first experimental investments in private equity, not all of which worked out. As is already well-documented, certain institutional investors built up a substantial exposure to private equity, often via poorly structured vehicles, with a very limited knowledge of what was involved.
“From an investor’s perspective, Switzerland is one of the most developed markets as quite a number of fund of funds are based here, says Stillhart . But she has noticed a disparity in institutional appetite: “Some institutions, which made direct investments and ended up getting burned, are sceptical about the asset class, whereas the appetite of other institutions is slowly coming back.”
Michael Peterson of 3i Schwiez, says: “Swiss institutional investors are still quite risk-averse and like to use capital-protected structures. They think their caution is justified because of the tech bubble.”
“In the case of prudent investors, who have built their exposure carefully over time, their performance goals are likely to have been met already or will be met in the near future,” Matter of Unigestion adds. “However, a minority of investors who jumped on the bandwagon before the bubble burst are disillusioned with the asset class.”
A certain number of institutional investors are particularly disillusioned with the degree of correlation between the alternative asset class and the long-only markets. They have learned the hard way that when things go wrong in the traditional asset classes the level of correlation is higher than they had been led to believe.
Switzerland also counts a high proportion of wealthy individuals, who are usually organised into family offices. These high-net-worth individuals (generally from Germany, Austria or South Africa) often lack sophisticated knowledge of the asset class and rely upon investment advice from private equity gatekeepers.
As a rule, Swiss institutional investors are likely to be more risk averse than their peers. “Currently, Switzerland has the lowest percentage of assets invested in private equity out of all the OECD countries,” Lattmann of Venture Partners notes. “The typical allocation for a Swiss pension fund hovers around 1%. This is considerably lower than the 3% average committed to the asset class across Europe and the US national average of 7-10%.”
He claims that this is due to the Swiss propensity for risk aversion and the low profile of the asset class. At the moment, private equity is not considered to be a separate asset class and tends to be lumped in with shares. This means that investors know little about it and consider it to be a risky investment.
Meanwhile, other large institutions have hired private equity specialists to set up their own portfolios in-house. Swiss insurance companies, such as Swiss Life and AIG, and banks such as Pictet & Cie and Lombard Odier, are more likely to have their own private equity structure. But following the poor performance of the equity markets in recent years, sophisticated investors have realised the importance of diversifying their asset allocation in order to be able to meet their asset liabilities. This liability-orientated investment strategy and the increasingly acceptable profile of the asset class have led existing investors to increase their allocations and new entrants to make their first investments, resulting in a significant inflow of capital into the industry.
As a new entrant to the private equity market, it can be difficult to access the best opportunities. Funds-of-funds managers have an understandable bias toward investors who realise the importance of a stable, long-term team and that good returns demand continuous investment in the asset class.
LGT’s Sneyers says: “Inevitably, some investors will allocate to underperforming private equity teams. It is important to remain disciplined and identify the good from the bad in order to avoid another boom and bust cycle. The key to avoiding disappointment is to build a diversified portfolio with exposure in every vintage year.”
The varying needs of this diverse investor base make it difficult for the private equity industry to satisfy investors’ demands. The small size of the Swiss market is an issue for investors, particularly as it is also divided along linguistic lines. Consequently, much of the capital raised domestically is spent abroad. “The Swiss market cannot satisfy Swiss institutional demand for the asset class,” Matter says. “This has made some Swiss investors more open to investing abroad than some of their European counterparts.”
A uguste Betschart, a partner at independent private partnership Leman Capital, agrees: “It is difficult to meet investors’ demands for deal volume. This is a small country and there is a limited number of deals.”
There is also a market perception that there are no truly institutionally qualified Swiss funds. In general, investors worldwide have a bias towards larger groups. Therefore, smaller Swiss funds, which may lack the requisite track record and network of contacts for attracting investor attention, will find it harder to raise funds than their more experienced international peers.
This said, Swiss fund management company Capvis Equity Partners is widely acknowledged to be as sophisticated as international players such as CVC Capital Partners, and has the advantage of being able to build a bridge to the international market while being Swiss.
Although by no means solely a Swiss problem, the issue of fees also needs to be addressed. In the past, investors globally have frequently voiced their displeasure at high management fees but now both investors and private equity managers are becoming increasingly concerned about the high transaction and director fees charged by the vendor.
Other common international complaints echoed throughout the private equity industry include lack of transparency and poor reporting skills from private equity managers. The lack of harmonisation across the industry, particularly concerning tax issues, is also cause for concern among investors who would like to see a common European standard and national associations working together as opposed to independently.