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Performing
for a larger audience
Long
thought to be an investment tool of the rich, private
equity is on peoples’ minds again and on trustees’ plates
for consideration. Angela Pasceri investigates
Not
an easy time to be fund raising but Candover’s fund managers
would disagree as they closed the first round of funding in June
for its 2001 Fund at E1.1bn. The London-based private equity firm
specialising in European buyouts and buyins would argue that the
time is right for private equity. Helen Walsh, the company spokeswoman,
says: “Although the fund raising environment is not fantastic,
if you are a fund that has consistently delivered, then investors
will come back to you. Over a 20 year investing period, we’ve
managed to maintain the top quartile returns on all our funds and
investors love it.”
Approximately 70 per cent of the raised capital came from existing
worldwide clients of which 25% are pension funds. She expects that
the percentage of capital from pension funds will probably surpass
its 1997 mark of 35 per cent because of the greater amount of attention
paid to private equity since the Myners Review.
In the UK, private equity has received a greater amount of attention
than before particularly among pension funds due to the Myners Review.
This looked at, among other issues, why institutional investors
did not invest more in private equity and whether there were barriers
inhibiting those investments. Although he did not make recommendations
regarding the level of investment in the asset class, Myners heightened
the attention to the investment vehicle. Larger, predominately final
salary schemes, have already been investing in private equity for
some time now; what Myners did was broaden the audience.
So why all the hype? Private equity has consistently provided annualised
returns in excess of 20 per cent over periods of three, five and
ten years. The British Venture Capital Association’s figures
for 2000 showed net returns of 25.6 per cent for private equity
significantly outperforming the FTSE 100 at -8.2 per cent, FTSE
All-Share at -5.9 per cent and the FTSE at 4 per cent. If you had
invested in the standard equity market benchmarked on the FTSE All-Share,
then the return you are going to get from any manager is not going
to be hugely different from the benchmark. There is no benchmark
for private equity and the returns achieved by different fund managers
can be quite varied so a great deal of time and attention has to
be exercised in selecting the right fund manager.
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Surprisingly, the amount of money invested by UK pension funds in
private equity, according to the BVCA figures, increased by 87%
compared to 1999 reaching £817mn in 2000. Baring Private Equity
Partners’ senior partner for western Europe, Mark Hawkesworth,
indicates that pension funds on average one to two per cent of the
portfolio is alloted to private equity. He notes: “Arguably
the UK has not followed the US in terms of allocation and indeed
there are one or two continental pension funds that are being quite
aggressive in terms of what they are allocating to unquoted securities,
sometimes five or six per cent.”
Richard
Bowley, chief executive officer of Pantheon Ventures, global private
equity specialists, agrees that now is the time for private equity
and his clients are also bullish with allocations of approximately
five per cent. He highlights three reasons for the favourable investment
conditions. First, as a result of the decline in the public markets
which has shrunk institutional asset pools, some of the more mature
US institutional investors in private equity are overweight in the
asset class and are therefore scaling back on new investments. This
is good news for the more recent European institutional entrants
who are gradually building their exposure to private equity over
time.
With the TMT bubble bursting and weak earnings emanating from equity
markets, prices across the board have come down and the entry costs
for private equity managers are much lower and attractive. “At
the same time,” says Bowley, “Pantheon believes that the
number of investment opportunities is growing, particularly in continental
Europe, where private equity markets are maturing and buyouts are
playing an increasingly important role in ongoing industrial restructuring.”
The keys to identifying a good investment opportunity in private
equity are, according to Glasgow-based Bill Nixon, investment director
at Aberdeen Asset Management, the people, the entry price, the market
and the exit horizon. The exit or how well you can unload is arguably
the most important variable. In the UK and Europe most disinvestments
are via trade sales, selling to another company. So although stock
market listings have been quite popular recently because of the
technology boom, in the longer term trade sales will continue to
be the preferred exit.
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Bowley
says: “It’s easy to make investments but more difficult
to realise them successfully.” The infrastructure surrounding
the investment has to be supportive. The absence of such an infrastructure
can compound risk particularly in emerging markets, while over-dependence
on the public markets can also be dangerous, as has been seen recently
in the US. “Wise private equity managers have never relied
on IPOs for their exits. Historically, the vast majority of realisations
in Europe have always been by trade sale,” he says.
One
step at a time
Adrian Swales, head of UK practice at Aon Consulting, finds that
in his experience, final salary schemes, depending on their liability
profile, that are well funded tend to consider an allocation of
approximately five per cent in private equity. “They’re
well funded and they have a surplus of assets so they’re looking
to make those assets work harder while maintaining the surplus,”
he explains.
In most cases, it is not so much that pension funds have decided
against private equity as an investment, they just have not thought
about it. Although more trustees are looking at alternative investments,
they have a lot to think about at the moment with corporate bonds
and hedge funds.
Private equity is also a complicated topic and requires you to take
a long-term view. It’s more complicated than equity investment
because you can’t just change your mind and get out of it.
You have to decide on a commitment and be confident that you can
stick with it for a long time, at least 5 or 10 years, and not all
pension funds are in a position to do that.
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The
other issue to consider is the MFR which operates on the estimated
yield. “Since private equity doesn’t have a yield –
well, at least nothing you can put your finger on – it’s
a huge mismatch if you’re totally funded on the MFR,”
says Michael Robarts, associate partner at Bacon & Woodrow.
Yes, the government is going to abolish the MFR, but until they
say when or how, it continues to apply.
It
is also much harder to make the case for private equity in money
purchase schemes because each member has their own individual part
and liquidity becomes more of an issue than it is for final salary
schemes. So the risk to individual members is greater.
Robarts explains: “The problem for DC schemes is that you can’t
spread the risk across a whole class of members. With a DC scheme
it’s pretty unlikely that most trustees would feel entirely
happy about including a venture capital or private equity option
in the structure until at least the schemes are a lot more mature
than they are at the moment. You don’t have the time scale
if anything goes wrong and it can impact directly on a single member.
At least with a DB scheme if there is a short fall there are other
ways of making up the gap but a DC scheme doesn’t have a planned
sponsor behind it and no obligation to make up the shortfall.”
Gissings’ head of investment practice, Steve Barker adds: “Those
investing in private equity tend to be larger pension funds because
they allocate enough in the area that it warrants spending the time.
If you’re putting £100mn or £1mn into private equity
it takes just as much time to find a good manager.”
The limited amount of time and resources trustees have to devote
to private equity is a driving factor for choosing fund of funds
managers. Barker notes: “If you’re looking at direct managers
they’re very heavily concentrated by geographic area, stage
of investment and often by industrial sector. So in order to get
a diversified portfolio you need 15 - 20 investments and to get
these investments would take up an inordinate amount of time for
most trustees so it isn’t appropriate.”
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Selecting
the fund of funds is an art. Gissings recommneds looking at how
thorough the fund of funds managers are in their investigation of
their underlying network of private equity managers. They also ensure
that the fund of funds is diversified so that there is no undue
concentration and that new managers are identified when and if they
come to the market. “It’s not a requirement that the managers
invest in first time funds but what we’d like to see is that
at least they’re looking at first time funds in order build
up relationships with the managers,” says Barker.
As optimistic as private equity managers are about their product,
trustees have so much to look at that if they are unfamiliar with
private equity then it is slotted further down the list, particularly
for smaller schemes. Things are changing and trustees are looking
at wider issues but we’ve got some time to go before trustees
move from considering private equity to investing in it.
–
Pensions Age July 2001 –
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