Inspired both by regulatory changes and the quest for good returns, private equity investment by institutional investors is set to grow in the Netherlands, according to a recent survey. While only 29% of financial institutions questioned had existing commitments to private equity, 35% stated that they were preparing to make allocations in the future.
The survey, of 100 institutions representing 30% of the Dutch institutional market, was conducted by the University of Tilburg and sponsored by Adveq, a private equity fund-of-funds manager based in Zurich.
Of the institutions surveyed, 46% were corporate pension funds and 25% were insurance companies, with the remainder representing other categories of financial institutions Together they account for €1,500bn under management.
Dutch insitutions rank additional portfolio diversification as the most important reason to explore the asset class. They may well be anticipating the effects of the new financial assessment framework (nFTK), due for implementation in 2007. The report notes that the nFTK will force a revision of asset and liability management techniques. “It is expected that in contrast to current practice, the new regulations will take into account the risk profile of an institution’s entire asset portfolio in relation to its liabilities. This may lead to increased participation in private equity, as increased diversification will be required.”
That said, Dutch organisations are also interested in increase of relative return. They expect an average absolute return of 10%, and an average outperformance over public equity of 315 basis points.
The most popular benchmark is the Thompson Financial/Venture Economics Benchmark Report, “despite the fact that the majority of their private equity commitments are within Europe”, the report notes; 33% of respondents used this, against 24% who use the MSCI World.
Less than one-third of the institutions questioned were currently committed to investing in private equity. These firms targeted investment at varying levels. For example, 10% of firms currently commit more than 10% of total assets to private equity, but the most popular commitment level was up to 1% of total assets, the level chosen by 35% of respondents which are current investors.
However, there is a significant difference between targeted commitment and actual drawn-down commitments. While those institutions with the most substantial commitment to private equity - 10% or over - are already fully invested, 45% of those questioned have drawn-down commitments of less than 1% of their total assets under management. In other words, while institutions are committed to the idea of private equity, they are not yet fully invested in the asset class.
Currently fund of funds and direct fund investment are the most common routes for participating in the asset class. Both account for 40% of current private equity allocations, with the remaining 20% consisting of direct investment. The report’s authors conclude that “this tendency to entrust private equity investments to financial intermediaries … is due to the high level specialist skills, management time, and resources required to successfully identify and monitor private equity investments. These are skills and resources that institutions which are new to the asset class do not have yet.”
Regionally. Europe (ex-Netherlands) comes out on top, accounting for nearly half - 46% - of private equity investment. The home country accounts for 22%, significantly less than the US, which came in at 27%.
There are marked regional differences in the means of entering the various markets. Dutch institutions prefer the direct route for their home market, either making direct company investments (31%) or direct fund investments (40%). Funds of funds play a more important role for investment in other regions, accounting for around half the investment in Europe ex-Netherlands, Asia, and the rest of the world – with the exception of the US market, where they account for 58% of total private equity investment. The researchers point out that, “as the institution’s proximity to the investment reduces, the need to rely on a fund of fund’s specialised expertise increases”.
As more financial institutions make allocations to the asset class – and as allocations grow in size – funds of funds are set to play a bigger role, the study found.
While the percent of institutions allocating more than 10% of total assets to private equity will remain stable, firms allocating up to 5% of total assets under management will increase from 17% now to just over one-quarter. As this trend materialises, direct investment into private equity funds is forecast to fall overall from its current 40% to around one-third, and fund of funds investment will grow to nearly half the market, up from 40% currently.
Part of this can be explained by regional preferences. As investment in the home market shrinks, direct investment will also shrink proportionately; and as that investment shifts further afield, there will be greater demand for indirect routes into private equity. Although Dutch institutions will still prefer direct investment for its home market, overall domestic private equity investment will decrease to around 18%, from 22%. US investment will grow 3% to around 30%, and Europe ex-Netherlands will increase by 2%to 48%.
Thus, in the domestic market, funds of funds will lose market share to direct investment opportunities, but in international markets they will increase. Where fund of funds will really come into play is in more exotic markets, outside Europe and the US. They will account for 71% of investment in this sector, up from not quite half currently, gaining at the expense of direct investment in funds, which will fall to under one-third, from 53% now.
Selection criteria are similar for funds of funds and direct investment of funds – track records of both funds and management, and fee structure, are all very important. However, when it comes to selecting funds of funds, the most important criterion is the managers’ ability to gain access to premier funds.
Dutch financial institutions are well prepared to participate in the asset class – only 15% of firms have no defined responsibility for private equity. Of the firms surveyed, 24% have in-house private equity units, and 18% have qualified employees with specific private equity experience. Otherwise, in 20% of firms questioned, the CIO is responsible for investment decisions. On average, Dutch financial institutions have three people responsible for private equity.