Size does matter
The market for private equity investment in southern Europe has grown considerably during recent years, but the interest among institutional investors in this region in considering this asset class as part of their
portfolios is still small. In general, more venture capital and private equity firms are launching funds investing in domestic companies in Spain, Italy and Portugal, but so far most institutional investors investing in them are coming from abroad.
In Spain, for instance, the size of the private equity market has doubled in the past year. The economic growth that Spain experienced as a result of economic measures applied to meet the single currency criteria has attracted a significant flow of money into private equity. Total funds under management exceeded Pta411bn (e2.47bn) in 1999, according to a survey on European private equity for the European Venture Capital Association (EVCA) conducted by PricewaterhouseCoopers. And it seems there is still room for further growth.
Madrid-based Mercapital Servicios Financieros has just closed a €600m private equity fund to new investors. Launched in May, Mercapital Spanish Private Equity Fund II is the largest private equity fund in Spain and has attracted institutional investors from all over the world. So far the fund has not attracted money from any Spanish pension fund.
“The Spanish pension fund market has developed a lot in recent years but the size of the schemes is still very small if you compare it to that of pension funds in other European countries,” says Javier Loizaga, executive partner at Mercapital in Madrid.
And since size is very important when it comes to considering alternative investment in institutional portfolios, it seems that this situation will not change for the time being.
“Pension funds in Spain have just done the migration from fixed income to equities,” says Loizaga. “The next natural step would involve introducing alternative asset classes but this is something that will take some time. It’s true, however, that there is a lot of intellectual interest in the subject and some of the larger pension funds already have some short of exposure to private equity having invested in funds outside Spain.”
Santiago Fernández, executive director of Fonditel, investment manager to Telephonica pension plans in Madrid, agrees: “I don’t see the interest of pension funds in Spain in private equity investments growing. Some of the people working for private equity companies say that the Spanish market, and in general the Southern European pension fund market, is underdeveloped and that because in other more developed markets, such as the UK or the Netherlands, the exposure to private equity is higher, this should be the way forward. But I don’t think that’s the case.
“I think they forget about the fact that most of the pension funds in Spain are defined contribution plans and private equity investment do not meet the requirements of these schemes that well.”
Fernández explains that private equity is by definition an illiquid asset class, more suitable for defined benefit systems. “When you have DC plans you have to know the daily valuation of your portfolio and private equity is only valued once or twice a year. This does not fit in with our institutional requirements.”
It also important to take into account that some of the firms offering private equity in countries like Spain, Portugal or Italy have had problems regarding regional and sectoral definition. “There are many houses offering private equity funds that only focus on a region, for instance Spain, but do not take into account the different industrial sectors,” Fernández says. “We are not convinced that that’s the best attitude because it seems that the houses which are achieving the best results are those investing in specific sectors across different countries.
“You also have to consider that structure of private equity investments is very expensive,” he says. “We still don’t find it clear that the investor, who’s the one taking the risk, can obtain much better returns than if they were investing in other asset classes. If you think that in the next 15 years the stock exchanges will give you returns of 10–11% and private equity will bring around 16%, the 5% difference can be seen as very attractive. But you can forget that about 3% will go for the managers.” Fernández believes that this very high and aggressive fee structure can only be justified in extraordinary cases where spectacular returns were obtained.
For Andrea Bonomi, managing director of 21 Invest group, which has offices in Madrid, Milan, Paris and London, asset managers focusing only on the fees structure of private equity investment are taking the wrong approach. “One of the reasons why they should be investing in private equity is that the returns are high and that, if properly done, private equity is unrelated to the vagaries of the stock market,” Bonomi says. “Managers who say that fees are too high are focusing on the wrong line, because when you are managing third-party money your goal should be to achieve the best returns and not to spend as little as possible.” A joint venture between Invest and 21 Investimenti, 21 Invest is one of the leading Southern European equity groups, and recently launched a fund for industrial investments. The new fund already has E300m in commitments and is focused on investments in mid-market buy-outs and build-ups, especially in Italy and Spain.
“Investors in our fund include a range of banks, fund of funds and insurance companies, as well as leading European family investment offices,” says Bonomi. Around 70% of commitments come from Europe-based investors.
“When talking about private equity investors you have to distinguish between two different types,” says Bonomi. “First you have the long-standing institutional investors, mainly Anglo-Saxon, that are starting to show an increasing interest in southern Europe and gravitate towards the most established private equity groups like ourselves and then there is a new range of investors who are just entering the market and are gravitating more broadly to the asset class rather than to specific groups making it possible for new groups to start up,” he says. Bonomi thinks that established groups like 21 Invest and Mercapital will still have the most consistent and best returns in the long term.
Bonomi defines the investing strategy of their new 21 Invest Industry fund as an ‘adding value’ approach. “We don’t think that in the future private equity funds can do transactions without adding value, and adding value today means a buy-and-build strategy across Europe and that’s why we have offices in different countries. We are business builders. We have a very small number of Italian investors because we decided not to market the fund in Italy but we see a growing interest among Italian insurance companies in private equity which is the future will be very large.”
Regarding the Portuguese market the ECVA survey highlights that the number of private equity companies operating in Portugal has not changed considerably during the last few years, but the amount of private equity raised in the country increased significantly in 1999 to Esc14.2bn (e71m) from Esc9.4bn in the previous year. During 1999 over 45% of private equity investments came from banks and around 20% from government agencies. So far the number Portuguese pension funds investing in private equity is minimal.
“We haven’t seen much interest from Portuguese pension funds in private equity investments,” says Carlos Ravara, senior consultant at Watson Wyatt in Lisbon. “There are minor private equity investments in some of the larger pension funds but the percentage of this asset class in institutional portfolios is still very small.” As opposed to hedge fund investments, where Portuguese fund sponsors are becoming more involved, the exposure to private equity is not expected to grow significantly in the near future.
In general, institutional investors in southern Europe trying to diversify their investment portfolios are seeing more opportunities in absolute returns asset classes, such as hedge funds, than in private equity investments. “We can’t say that we don’t invest in private equity because we don’t like this asset class or we don’t believe in the returns it could brings to our portfolio,” says Fonditel’s Fernández. “It’s just that we think that there are other asset classes that meet our requirements better.” Although Fonditel is not currently investing pension fund assets in private equity they have some exposure to this asset class in the gestora’s internal portfolio. “It’s only a very small amount of money. It’s what I called a ‘learning investment’ and it’s just a symbolic amount. The only reason why we are doing this is to find out how it works and if the results are as good as the private equity houses’ brochures claim to be,” he says.
Those investors in other countries in Europe which already have exposure to this asset class are seeing southern European private equity as an important way to diversify and achieve better investment returns.