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Keeping the faith in PE

If investors are losing faith in politics, fiscal policy and economic cycles, private equity is proving to be something in which they keep believing, as Elizabeth Pfeuti explains…

Almost a third of investors responding to Preqin’s report into alternatives in the first half of 2019 said private equity had exceeded expectations over the past 12 months. An additional 61  per cent said they were satisfied with the outcome of their holdings. Compare that with 46  per cent of hedge fund investors whose expectations have not been met, followed by 37  per cent of investors in natural resources claiming the same. 

With wayward listed equity markets wiping out much of 2018’s gains in the final quarter, private assets’ less volatile characteristics may have smoothed the way into investors hearts. But the majority of private equity investors also do not think last year’s performance was a blip. 

Some 56  per cent said they thought the asset class would perform as well in the next 12 months, with 22  per cent foreseeing even better results. 

Little wonder, then, that some 40  per cent of investors told Preqin they were keen to plunge more into private equity, with 47  per cent retaining their current allocation. 

But if history has taught investors anything, it is that all funds are not created equal. 

A behemoth fund raised by a giant US investment group is a very different animal to a small, sector-focused vehicle run by a European mid-market house.

Despite – or maybe because of – this, pension funds and their advisers are gearing up for a buying season in private equity – and it looks as if there will be winners across the board.

Shopping spree

Tom Baird, vice-president in manager research at London-based investment consultant Redington, says: “With the growth of the asset class we’re seeing increased demand for private equity allocations, especially for larger schemes with the governance and illiquidity budget to warrant an investment.”

Redington works with pension funds and other institutional investors with close to an aggregate GBP500 billion in assets under management. 

There is no set way investors are accessing private equity and the percentage of the overall portfolio being allocated can vary widely “depending on illiquidity budget, time horizon, governance and general views of the asset class,” says Baird. “It can be a meaningful allocation, but still often sits within the ‘alternatives’ bucket for investors with a lower weight compared to public equity and fixed income.”

Nick Hinchliffe, investment director Private Equity at LPP, which invests the assets of three large public sector pensions, says private equity remains “a core component of client portfolios”. 

“We commit to funds very selectively, have committed to one manager to-date in 2019 and are reviewing a second,” says Hinchcliffe.

Ole Rolleg, founder of Pueblo, a service that helps match private equity funds with investors, says he has seen the take up of the asset class on the rise, too.

“This is primarily driven by the public markets showing the strain of being towards the end of a bull-market cycle propped up by ultra-low interest rates for an extended period of time since the last financial crisis,” says Rolleg. 

With claims the global bull run must soon end dating as far back as 2017, this has given investors pause for thought. 

And while investors from around the world are increasingly interested in private markets, it is difficult to generalise as to how geographical location impacts holdings, although there is an ‘Atlantic split’. 

According to Rolleg, the average US institutional investor might have a 10-20  per cent exposure to private markets, of which private equity could be the majority. A European institutional investor might allocate up to 15  per cent of their portfolio to private market opportunities, but not more, he says.

Big fish, specialist fish

Compared to 10 years ago, when alternatives as a sector made up a small fraction of institutional portfolios, these allocations can now be seen as significant. Some USD9.5 trillion sat in the sector at the mid-point of 2019, according to Preqin, with private equity one of the largest holders of capital. 
But where has the money gone – and are specialist or generalist funds set to be the main beneficiaries of the continued good will towards the asset class?

According to Rolleg: “The short answer is both, but we see a discrepancy between European investors and investors in the US. In a European context, smaller investors tend to focus on generalist funds whilst more sophisticated European investors opt for single sector opportunities.”

The longer answer is one of size. 

“In the US, smaller investors tend to prefer more specialist managers, be that sector plays or manager with significant experience with a specific region/broader sector,” says Rolleg. “More sophisticated private equity investors opt for core holdings in generalist managers and then look to make satellite investments to sector plays based on their market outlook.”

These specialist add-ons grasp at opportunities not aimed for within the overall portfolio. Growth sectors, such as technology and healthcare, have been the firm favourites in recent years, says Rolleg, and even these are being broken down into sub-sectors. 

Baird at Redington says typically investors were looking for GPs with a particular niche or demonstrable edge in generating alpha. 

“This can come in the form of sector specific funds or region/country specific funds,” he says. “While this can also be present in generalists it’s easier to identify with those that can clearly display their differentiated edge/skillset within a particular market.”

All roads lead to PE

In a growing universe of opportunities of all sizes, LPP does not close off any avenue of exploration and is open to all types of funds. The GBP17 billion investor takes a range of factors into account when allocating.

“We consider macro-economic factors as part of our top-down allocation policy, but the final decision to commit to a fund is based upon the bottom-up attractiveness of any single manager,” says Hinchliffe. “We have invested in sector specialists and strategy specialists, on the basis that specific skills or knowledge can be a differentiator. However, we also invest with generalists, where there is a strong record, an ability to evidence how this was achieved and where it can be sustained in future funds.”

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