Practitioners who invest in venture capital and private equity spoke up about the opportunities and risks for pension funds at a recent event organized by the Swiss venture capital and corporate finance association (SECA).This content was published on April 25, 2003 - 11:50
There are many aspects to investing in private equity and just as many opinions on how quickly or not pension funds will move into the asset class; however, practitioners do agree that private equity is attractive and meets the need of finding investments with good returns, despite market volatility.
There is going to be more transparency in the private equity business than there has been in the past, said Ivan Vercoutere of LGT Capital Partners, a company that manages and sells alternative asset products.
He goes on to say that California and Texas based pension funds have published information about their holdings and the performance of individual fund managers.
For new investors to the asset class, the task of judging and selecting is challenging. "The private equity market is not transparent nor is it efficient," states Vercoutere, an alternative asset fund manager. "If there was such a thing as an "index" of private equity partnerships, the returns would be on par or even below public equities returns," explained Vercoutere.
The idea is that private equity should not to be taken as a whole. The goal is to identify the best fund managers (top quartile partnerships) out of the 4,000 or so partnerships available worldwide, and only invest with them.
"Private equity is attractive because of the potential for 'excess returns', typically earned by the top-quartile partnerships. The spread of long-term returns between upper and lower quartile private equity funds is significant, compared to less than 3 per cent in public equities and less than 1 per cent in fixed income," said Vercoutere.
Picking fund managers
Picking the right private equity fund managers therefore is the critical aspect of investing and it should not be left to the inexperienced, or to chance.
Practitioners discussed how some pension fund managers "dipped" into private equity in the nineties without a specific strategy, without knowledge nor proper due diligence. They did direct investments into startup companies and investments into dubious foreign vehicles, rather than organizing a strict, disciplined private equity "program", as the practitioners call it.
Furthermore, they invested without adhering to some of the basic rules of portfolio management. For example, Urs Wietlisbach of Partners Group said his firm had acquired the PE investments of a Swiss pension fund in the so-called secondaries market. The fund in question had allocated 200 million to PE back in 1990.
It put the whole amount all at once into one vehicle. The results were pathetic, he said. Its approach broke the golden rule of investing, which is to diversify. In private equity terms that means diversification over vintage years, vehicle type, and investment strategy (buyout and venture capital), as well as geography.
But even before diversification, a pension fund has to be sure that it is big enough to allocate funds to private equity. There has to be enough room for diversification within the asset class - that is, they should be able to diversify between funds and managers.
Investors have to take a long-term perspective and the commitments must be appropriate. First time investors in private equity and smaller pension funds may consider investing in funds of funds, say practitioners.
According to Robert Nef, who manages Swiss Re's SFr2 billion pension fund, the decision to make an allotment for private equity was made two years ago. It calculated that it could allocate three percent of its assets to private equity. It wanted a low volatility vehicle, so it chose a fund of fund.
Then it diversified over vintage years, types of PE (buyout and venture capital) style, geography, and industry sector, and type of vehicle (fund of fund, limited partnership, or listed private equity firm).
The economy card
Some investors believe that PE can reverse the negative growth trend that Switzerland has witnessed in recent years. One member of the audience said his analysis of the economy reveals that trying to "preserve" wealth is stalling the country's growth.
There are more millionaires per capita than any other country in Europe, he said. It is time to start putting cash reserves to work by investing in innovative and growing small and medium sized businesses.
Arguments such as the economic one are irrelevant at a time when pension fund managers are facing a shortfall in their reserves, responded pension fund manager Daniel Dubach, Chief Investment Office of ABB's pension fund.
Today private equity is seen as an additional risk, explained Dubach. Because pension funds tend to be cyclic investors, there will be no increase in allocation to private equity until some "success stories" start to emerge.
If the venture capital and private equity industry in Switzerland wants to attract institutional investors, then they should forget about lobbying politicians to "mandate" investment, rather publish good results in the Financial Times, said Peter Gale, Head of NatWest Fund Group's, Gartmore Investment Management.
Practitioners agreed with the British fund manager, although they felt that the Swiss industry would be better to publish performance results in the Neue Zürcher Zeitung or one of the other business and finance publications in this country.
There is little doubt today that private equity holds potential for all kinds of institutional investors as a part of a larger portfolio of assets. But due to the sector's intransparency, it takes a great deal of effort to learn about investing in it.
As Dubach put it, there is a need to bridge the knowledge gap. Pension fund managers might be sitting on a mountain of money that could be better invested, but SECA members are sitting on a "knowledge mountain" that needs to be transferred.
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