Pension fund trustees in the UK should invest more in private equity, according to a report on the private equity industry by the London Business School of Business, launched last month by the British Venture Capital Association (BVCA)
Olivier Burgel, research fellow for the Foundation of Entrepreneurial Management at the London Business School says: “The aim of this report was to look at the fact that private equity and venture capital are suitable as investments for pension funds.”
They examined the private equity returns, risk and cash flow. “Regarding returns, what our findings demonstrate is that on a long term basis, British venture capital has outperformed the other major British asset classes, such public equity and bonds,” Burgel says.
“One of the common misconceptions about venture capital is that everybody says that returns are higher because of the higher risk. However, the report shows that if you have an appropriate diversification, the risk is comparable to the risk of public equity investments.”
“Another misconception, this time in terms of cash flow, is that pension funds which have achieved a certain level of maturity should not invest in cash because it is illiquid,” says Burgel.
The report highlights that even the mature funds should consider cash because, after an initial period, it can offer strong positive cash flows from as early as two years after the first drawn down. With these results, trustees should increase their investments in private equity, taking into account that UK pension funds commitment to this asset class dropped sharply in 1998.
Based on a simulation where the cash flows in private equity were invested in benchmark tracking funds, the report finds that, since 1987, cumulative private equity returns have outperformed UK equity returns by a narrow margin and all other major UK asset classes by a substantial margin between 240 and 460 basis points.
The London School of Business recommends that the decision to invest should be taken with a long-term perspective in mind since it takes three to five years to before investors experience positive returns and net cash flows.