EUROPE - Some institutional investors in private equity have lowered their allocation because of concerns over a mismatch between target net internal rates of return (IRRs) and realised net-of-fee returns, research has found.

According to a survey conducted by the consultancy bfinance, institutional investors have lowered their expected returns in most strategies, resulting in a significant amount of capital remaining uninvested, high competition for transactions and extended holding periods driven by lack of financing and liquidity constraints.

However, the majority of the 41 institutional investors surveyed pointed out that some strategies - such as private debt - still offer a better risk adjusted return, given their capacity to align past returns closely to future expectations.

As a result, 74% of these investors expected a net IRR of over 10% from investing in private debt and nearly 70% said they had achieved the target.

Emmanuel Léchère, head of the market intelligence group at bfinance said: "Clearly private equity has a major role to play in enhancing overall returns but to align actual returns with future expectations, more institutional investors need to adopt a dynamic rather than an opportunistic approach to portfolio management that emphasises stringent management selection, monitoring and negotiation in order to maximise the potential of investments in this asset class."

Even though over half of investors have a dedicated programme that gradually builds up their private equity investments, only 20% have a tailored investment programme that dynamically adjusts new commitments to maintain the diversification target at the underlying company asset level, according to the survey.

In addition, only 7% of investors actively manage their portfolios by doing side deals with secondary or co-investments outside the direct fund commitment.

Lorenzo Rossi, managing director for private markets at bfinance added: "Average returns in the asset class often do not justify the illiquidity and too often realised returns net of all fees fall short of expectations.

"Therefore investors need to focus on selecting the right managers that can create superior absolute returns. Amongst these, investors should seek out those that are correctly aligned to extract value for investors rather than for themselves."

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