UK - Research showing that asset allocation to private equity of nearly 20% for a pension portfolio that 50% invested in equities is an ‘efficient’ figure has been issued by Standard Life Investments (SLI).

“Such an allocation is unrealistic,” says the Edinburgh-based asset manager, which runs 1.8 billion euros in private equity investments. But it believes exposure to PE should be higher than the 3.6% currently among European institutional portfolios.

“We performed analysis of 10 PE funds invested mainly in the UK where we had six-monthly valuations for a period of nine years to 2001,” says SLI. “The internal rate of return (IRR) for each fund was calculated on a cumulative basis to the valuation point. In all there were 167 data points.

The total returns for the FTSE All-Share Index was calculated for the same period. “The average set of data for the whole period was calculated to be 0.22.” This suggests that PE fund returns do move in the same direction as listed equities, but they offer significant diversification benefits, says SLI.

By plotting an efficient frontier, risk is reduced and return is increased by moving from 100% listed equities. At the optimal point the extra risk from an incremental increase in allocation to PE balances the extra return. “In this case it represents an allocation to PE of 39.3%. Assuming equities account for 50% of total asset allocation this translated to a 19.6% asset allocation.”

Among the reasons why such a high allocation is unrealistic, says SLI, is that the PE market could not accommodate it currently. But it also warns that its sample, may not be representative. “Different results could be obtained from a different sample.” But the risk and return characteristrics suggest a higher allocation than is currently the norm in Europe, SLI adds.

SLI has total assets under management of 75 billion pounds (108 billion euros).

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