Good news for private equity fund raising?

UK pension funds have been acting on the last few years of underperformance in their listed equity portfolios. If the increase in the business fortunes of index tracking managers, such as Legal & General Investment Management and Barclays Global Investors is anything to go by, the trend appears to be away from active management. Lisa Bushrod reports.

The rationale is straightforward. Simply, UK pension funds have paid a lot of money over in fees each year to active fund managers, many of which have either barely outperformed the stock markets’ overall rise or failed to match it. As such, the cheaper option of passive management, where a fund manager is paid considerably less to track a recognised index, such as the FTSE-All Share, appears to be coming back in vogue.

The assessment, however, hasn’t ended there. These funds need to grow their assets quite substantially over time so while index tracking can be a reliable way of producing middle of the road returns (boom and bust cycles excluded), pension fund managers are having to consider how they can get that uplift in performance into their portfolios.

Roger Urwin, global head of investment consulting at Watson Wyatt, speaking in connection with the Watson Wyatt/ Global Investor magazine global survey into investment in alternative assets during 2004, said: “Pension funds continue to reduce their reliance on equities as they find suitable alternative sources of risk. The message of diversification is definitely getting through.”

The survey found that pension funds globally invested over US$62bn in alternative asset classes during 2004, comprising US$30bn in property, US$17bn in private equity and US$16bn in funds-of-hedge-funds, according to a survey by Watson Wyatt and Global Investor magazine.

The survey also found that private equity managers account for US$193bn, having grown their assets by 14% in 2004 and were responsible for 17% of the new inflows, mainly from North American pension funds. New inflows in 2004 in Europe saw pension funds providing most of the new money, but in the majority they invested in property, rather than private equity.

Urwin said: “Private equity is slowly gaining acceptance among pension funds globally as a logical addition to their portfolios. However, the governance budget required to be successful with private equity remains large.”

Also of interest was the source of the capital flowing into alternative assets during 2004. The survey found that funds-of-hedge-funds obtained 82% of alternative asset funds received from high net worth individuals during 2004, 76% of funds were received from other institutions, such as governments, endowments, supra-nationals and central banks, but only one-third of funds received were from insurance companies and mutual funds.

This may highlight the fact that high net worth individuals can easily gain access to funds-of-hedge-funds, which is simply not the case with private equity funds, where a minimum commitment of circa €10m is often required. Such high numbers mean high net worth individuals are likely to turn away from such investments as they would leave them under-diversified. Currently high net worth individuals are limited to gaining access to private equity through angel club networks, listed vehicles and feeder funds, operated by the wealth management divisions of the merchant and investment banks.

While UK pension funds are seeking stable returns from index tracking passive fund management for the bulk of their assets and increasingly looking to alternative assets to boost their overall portfolio performance and high net worth individuals appear to be doing the same, Gary Robins, CEO of Hotbed, the private investor network, believes the cases of UK high net worth individuals seeking private equity exposure is likely to increase further next year.

Robins notes that private equity is likely to play an increasingly important role in a balanced pension portfolio when plans, launched by the UK Treasury, to allow direct investments in unquoted companies into Self Invested Personal Pensions (SIPPs) come into force on April 6 next year. He points out that under current rules, SIPPs can only gain exposure to private equity by investing in quoted companies of funds that invest in unquoted businesses (such as investment trusts or venture capital trusts.)

Robins says: “For SIPP investors, who tend to be of an entrepreneurial mindset, the whole point is that they want to be in charge of their own pension fund to increase returns.” He goes on to say: “With industry experts estimating that SIPPs are, on average 25% invested in cash, taking advantage of the new more flexible rules will be key to driving up overall pension funds. Investing in private equity needs careful consideration given the risk profile of the asset class, but with the right strategy it could be a vital component in a balanced portfolio.”

So while the decline in occupational pension schemes is largely lamented by the private equity community, interest in them as an asset class is in fact growing and the challenge will really be for the industry to create access points for the huge wealth of high net worth capital already flowing through the system.