Healthcare and technology have not gone out of fashion for institutional investors, but these investors are looking to a small number of managers to deploy their capital, and ones that are crisis-hardened too…
This article first appeared in the December 2022 Investor Interest Insights Report
Healthcare and technology have not gone out of fashion for institutional investors, but these investors are looking to a small number of managers to deploy their capital, and ones that are crisis-hardened too…
At a board meeting in September held by the largest pension fund in the US, Nicole Musicco – the CIO of CalPERS – described the period between 2009 and 2018 when CalPERS was under-allocated to private equity as a “lost decade”, costing it an estimated $11 billion to $18 billion in returns.
CalPERS currently allocates 12% to private equity and must commit at least $15 billion annually to reach its target. Like many other pension funds and institutional investors around the world, it is now reluctant to pull back.
At the SuperReturn North America conference in New York in October, other US pension funds discussed how they wanted to stay committed to the asset class in a volatile market, despite being stretched past their current allocation targets by the denominator effect.
The solution for each appears to be quite different. While CalPERS has sold around $6bn worth of private equity fund stakes this year to free up capital for new commitments, Oregon Investment Council and others have been advised to lift their target range for the asset class to accommodate the current mismatch in public and private valuations.
In the UK, the recent LDI crisis has placed a spotlight on liquidity among pension funds there too. The FT reported in November that pension funds will have a reduced appetite for more illiquid holdings and some may look to sell their stakesin buyout funds. “The issue with private assets is that, in times of stress, they can’t be mobilised,” said Vincent Mortier, chief investment officer at European asset manager Amundi. “There will be some new thinking about liquidity management in order to avoid being trapped and having to sell things in a desperate way.”
In Private Equity Wire’s investor interest survey, liquidity ranked below both fees and ESG as a priority for asset managers and institutional investors in 2023 – the same as private wealth investors. According to Stephen O’Neill at Nest, most pension schemes keep ample liquid assets. “The far bigger challenge is that our overall risk exposure becomes imbalanced by the sticky valuations in private assets,” he says.
While the current situation could send a significant amount of investor capital into equities that have fallen in value, O’Neill says Nest is unlike many others in that it is still in the ramp-up phase for private equity and is therefore “still committing more capital to bring [it] up to our strategic target weight”. There are other examples of pension funds ramping up too. Laura Hill at Corsair Capital makes reference to a US corporate pension scheme with excess capital that will double the number of fund managers they are using next year, from five to 10.
For such LPs there is an opportunity to commit to high-profile managers that may have previously been out-of-reach. “Where maybe some LPs are now pulling back a little bit in terms of their allocations, this presents an opportunity for investors with capital to deploy like us to take advantage of this situation and potentially obtain greater access to more capacity constrained strategies,” says Christian Dobson, portfolio manager at Border to Coast Pensions Partnership.
For institutional LPs above their target weight on private equity, GP relationships are being consolidated (see Chapter 1), yet the strategies and sectors they want exposure to have changed little since the pandemic.
In the Private Equity Wire survey, buyout, venture and secondaries remain popular for almost all investor types but among institutional investors, 50% want to increase their exposure to sustainability and impact funds – more than any other strategy. This trend has been building among investors long before the pandemic but is more pronounced in a tighter fundraising environment. It is also likely to favour the impact funds launched or established by the larger, brand name managers over the past two years (see Private Equity Wire’s February’s Insight Report ‘Creating Values’).
Across all strategies, LPs are also showing more attention to managers that can demonstrate a track-record of performance through previous downturns.
“We are always conscious in building that diversified portfolio for partner pension funds,” says Dobson. “We look for managers that have performed consistently through economic cycles and who we believe offer repeatable, executable strategies, rather than those dependent on a specific market environment and who present greater volatility of returns.”
A recent investor survey by Montana Capital found that investors broadly have turned to resilient industries such as healthcare and business services, and investment strategies expected to be less impacted in a downturn, such as mid-market buyouts and secondaries. The survey found secondaries to be the number two long-term strategic preference of investors behind mid- market buyouts and ahead of growth capital, venture capital and private debt.
In terms of sector preference, healthcare and technology have not gone out of fashion for institutional investors in the Private Equity Wire survey, with financials and transport not far behind. The mid-market will be a favoured route here for LPs seeking to capitalise on lower valuations that may come in 2023. Around a third of LPs are planning to increase exposure to lower mid-market and mid-market buyouts over the next year, according to Rede’s H2 Liquidity Index. It also found that 30% of LPs plan to increase deployment to healthcare-focused funds next year, and enthusiasm for sustainability and impact has overtaken technology.
Perhaps not surprisingly, retail/consumer and energy showed marked decreases in interest from institutions indicating a risk-off sentiment for 2023. In contrast, energy was the most popular sector for private wealth with 64% indicating an increased allocation and it being the second most popular sector for asset managers.
