Over the last few years, the Nordic region has become one of the richest seams for private equity firms on the fund raising trail to mine. Some institutions have been investing in the asset class for ten years or more, but there have been other, newer entrants to the market. The overhaul of Sweden’s national pension fund system at the end of 1990s, for example, boosted demand for private equity in the region. In addition to creating a fund entirely devoted to private equity investment, AP6, the new system also allowed the other funds (AP1 to AP4 and AP7) to invest up to 5% of their capital in private equity. Reforms such as this have provided an impetus among Nordic institutions to conduct asset and liability modelling (ALM) studies over the last few years. Many of these concluded that the institutions in question should either start investing in private equity or should increase their allocations to meaningful levels; to around 5% or more.
Some of the available figures bear this out. Over 60% of investment institutions in Denmark, Finland, Norway and Sweden have allocations to alternative assets, according to a study conducted last year by Prospera Research, with more investors committing to private equity than hedge funds. The average amount invested in alternatives across the region is 3%, with Finland recording the highest at 6%, then Sweden at 4%, followed by Denmark with 2% and Norway with 1%. These percentages may not seem high, especially as they include investment in hedge funds, but it is reasonable to assume that they will increase over time as more investors come close to reaching their higher target allocations.
The region’s first steps into the asset class were prompted by difficult economic conditions in the 1980s and the formation of private equity funds established to take advantage of these. “There were a lot of opportunities in the late 1980s and early 1990s in the region that stemmed from restructuring industry,” says Lauge Sletting, head of fund-of-funds at Nordea. “Institutions became interested in the funds that focused on turnaround and leveraged transaction strategies, whereas previously they had invested directly in unquoted companies. These funds did very well and generated some very interesting returns.”
Most of these investments were made on an ad hoc basis and at a low level. Until recently, few, if any, institutions in the region could claim to have an established private equity strategy. Most stuck to investing locally; they didn’t have the time or the inclination to look further afield. “Historically, private equity wasn’t seen as an asset class in its own right in the Nordic region,” says Martin Anthonsen of Nordic Alternative Investment Advisers. “Investments made before the mid to late 1990s tended to be opportunistic and made in parallel with quoted equity investments. No- one really had the resources or the ambitions to set up a specific programme.”
But times have changed. “The stock market crash in 2000 led many Nordic institutions to question the large amount of quoted equities they had in their portfolios,” says Anthonsen. “As a result, they started looking more closely at investing in alternative asset classes such as private equity and hedge funds.”
With the increase in allocations has come an increase in focus and resources for many institutions. It’s a trend noted by John Barber of placement agent Helix Associates, which recently helped raise Altor Equity Partners’ maiden €650m fund. He has been surprised at the speed of development many institutions have undergone. “Attitudes to private equity have changed dramatically over the last few years,” he says. “A few years ago, you would often have to spend quite a lot of time educating investors about the asset class if you were attempting to raise funds in the region. Nowadays, many have specific programmes dedicated to private equity and there’s a much wider recognition that it will not move the needle of their overall returns unless they invest 5% or more. The institutions are now clearly in it for the long term.”
ATP is a good example. Established in the 1960s by the Danish government as a supplementary pension scheme, the fund had invested occasionally in private equity over the years. In 2001, it had 0.5% invested in the asset class, almost exclusively committed to Nordic funds. Following an ALM study that year, which recommended an increased exposure to private equity, ATP set a target allocation of 10% of its E40bn assets.
It’s a staggering increase. But what is interesting about ATP is the way in which it decided to manage the portfolio. With such a large amount going into private equity, the fund realised it was going to have to run the programme along professional lines. “ATP set up a fund-of funds structure,” explains ATP Private Equity Partners vice president, Susanne Forsingdal. “We are a general partner and we receive carried interest just like a normal fund-of-funds. We were set up this way to ensure that the managers’ interests were closely aligned with those of ATP and so that we could attract the right people. The only real difference is that we simply invest ATP’s money rather than seeking third-party capital.” Initially, ATP’s legacy portfolio was transferred into a fund managed by ATP PEP. Then in 2003 the fund received its first commitment of just over €1bn. That fund is now around 70% committed and the next investment from ATP, again likely to be around €1bn, is scheduled for early 2005. To manage all this money, ATP PEP now has a total of 12 investment professionals.
With so much capital to deploy, ATP PEP was never going to restrict itself to the Nordic market, as it had mainly done before. It has made commitments to some local funds such as those raised by Polaris, EQT, Nordic Capital, Healthcap and IT Provider. But it does not have a specific allocation to the region. Nordic funds fall into ATP PEP’s overall European allocation. “In general, we are open towards Nordic opportunities and we will conduct due diligence on all the funds in the region,” says Forsingdal of ATP. “But the bar is just as high for local fundraisers as it is for any other fund. We consider private equity to be a global game and we wouldn’t invest just because a fund was local.”
Few Nordic limited partners have ATP PEP’s firepower, but its international outlook is now typical. “Appetite for private equity among Nordic investors is increasing,” says Forsingdal. “Many started out by investing in local markets, as ATP did. But most now see that it makes sense to diversify their portfolio geographically.” Barber at Helix agrees. “LPs in the Nordic region have surprisingly internationally diversified portfolios if you take into account their immaturity. Many of them have gone through a lot of shoe leather, travelling extensively to do their research. Some of them have even made direct investments in the US. They have climbed the learning curve very quickly.”
For most Nordic LPs, gaining international exposure means investing via fund-of-funds or hiring advisers to do the origination and due diligence work for them. Many institutions are either too small to invest internationally themselves or have found that it is too difficult to attract managers with the right experience to manage a properly diversified portfolio. “There are a lot of newer LPs in the region,” says Anthonsen. “Most of them won’t invest in funds outside the region themselves; they’ll use fund-of-funds or advisers and gatekeepers instead.” This increased demand is one of the reasons his firm spun out of insurance company, Lansforsakringar in 2002. The team had been running the company’s Nordic alternative investment portfolio for a number of years (and continues to do so) and recognised that demand for gatekeeper-type services in the region was on the increase. It made a bid for independence and now advises a number of institutions in the region on their private equity fund investments.
Denmark’s Bank//Pension, which manages the pension contributions of the country’s financial services employees, provides one example of how smaller LPs are seeking to build their portfolios. It has chosen the fund-of-funds route to ensure that it gets a decent international diversification in its private equity investments without having to hire an army of people for what is essentially a small part of its overall portfolio. It started investing formally in private equity in 2001 and it now has €140m committed to the asset class. Two-thirds of this is invested with international funds via fund-of-funds, a proportion that will more likely increase than decrease, according to its senior vice president, Leif Hasager.
Sweden’s AP7 is another. Its target allocation to private equity is 4%, or $200m, and it has gone the fund-of-funds route. “All our investments are outsourced,” explains chief analyst Daniel Barr. “Our fund was designed this way because we took the decision that running all asset classes, many of them containing international elements, from Stockholm just wasn’t going to be feasible.” It made its first commitments two years ago and has so far committed to Hamilton Lane and HarbourVest Partners funds. It has more recently established a relationship with LGT Capital Partners, which is running an evergreen vehicle for AP7, to give it exposure to the European market. AP7 has also invested in about eight listed private equity vehicles to help beat the problems associated with reaching a target allocation, when it takes years for committed capital to be drawn down. These include LGT’s Castle Private Equity, 3i and Pantheon.
What of the local players?
This increasing internationalisation of private equity portfolios among Nordic LPs is clearly beneficial to firms outside the region. But where does that leave domestic firms? As Bank//Pension senior vice president, Hasager says: “Funds in the region have historically relied heavily on local investors.” It’s a question that occupies the mind of Martin Hansen of the Danish Investment Fund (DIF) on a daily basis. The DIF operates a E350m state-backed fund-of-funds that has the aim of fostering Denmark’s venture capital and private equity industry. Hansen welcomes the fact that Nordic investors have now embraced private equity as a means of boosting their overall returns, but he is concerned some general partners don’t realise that LPs are looking increasingly at other markets. “With increased sophistication among Nordic LPs has come an appetite for finding fund managers with a lot of experience and an excellent track record,” he says. “There are plenty of these in the Nordic region. But there are also plenty in the UK and continental Europe and there’s little good reason for LPs simply to concentrate on local players. The fact that many of them are using fund-of-funds and gatekeepers is another reason for money being diverted from Nordic funds. The problem is that many firms here haven’t yet recognised that they are now competing for capital on a global level rather than a local one.”
One consequence of this trend, he believes, will be fewer firms in the region. “The Nordic market has to consolidate,” he says. “We need to see fewer firms that together have a larger LP base. The funds themselves have to start looking further afield for their capital. In any case, it’s no longer feasible to try and run a E20m to E30m fund, although we see a lot of people trying to raise amounts as small as this. I think the minimum is E80m to E100m, otherwise you can’t afford to hire the right people and you can’t finance the management company.”
Jan Ohlsson, CEO of what is now Accent Equity Partners, could see many of the problems involved in trying to keep small funds in operation. He was CEO of Nordico, a firm he founded to manage out the assets of investment firm KF Invest. Faced with the prospect of two of his investment managers retiring, he approached Euroventures, a firm that was operating in a similar space; the lower end of the Nordic mid-market. The two firms combined forces in 2003. “We wanted a greater critical mass,” explains Ohlsson. “The Euroventures team’s skills complemented our own, so it was a good fit. But it also enabled us to broaden our investor base.”
Accent is currently on the fund raising trail with its first fund as a combined entity. It held a first close at E75m at the end of last year and is targeting a E200m final close over the coming weeks. What’s interesting about the fund is that it is the first time the team has sought to raise capital outside the region. It has some local support, about 35% of the capital is set to come from Nordic investors, such as AP6 and AP4, but the rest will come from the US and other parts of Europe. “The larger size of our fund meant that it was essential to raise capital outside the Nordic area,” explains Ohlsson. “But we also felt that we wanted to diversify the sources of our capital and find investors that we knew would be with us over the long term.”
And Accent isn’t alone in looking beyond local borders for fresh investors. “Fund raising among Nordic firms is becoming much more international,” says Anthonsen. “You’re seeing even smaller groups go further afield and employing international placement agents. It’s harder to raise capital now than it used to be. LPs are much more focused on quality, which means that funds are knocking on as many doors as possible. They also recognise that building up an international, diversified LP base is a smart thing to do.” Recent international fund raisings include Altor’s E650m fund, which attracted 40% of its funds from the US, 35% from Europe (not including Nordic LPs) and just 25% from local investors; and Nordic Capital’s E1.5bn fifth fund, which raised only 21% from Nordic investors. Even the E73m fund raised last year by Norwegian fund Four Seasons Venture attracted capital from investors outside the region.
As Anthonsen points out, this is no bad thing for general partners, even if it does mean a lot more time than previously spent globetrotting when fund raising. What this, together with the increasingly international approach of investors, reflects, is a maturing market. Many funds have become too big to be raised simply among Nordic investors and many institutions’ private equity programmes have equally become too large to be satisfied purely by local funds. But it’s more than that. Both sides are recognising the value of diversification; on the LPs’ side of the investments they make, and on the GPs’ side of their investor base. What was for many years essentially a local market has now gone global.