Pension funds across Europe have become more heavily focussed on private equity in the last two years. Funds in the Nordic region – in particular – are still in the process of moving into these pre-quoted investments.
In Scandinavia, as elsewhere in the developed world, institutional investors are turning to private equity for the same reason they are turning to other forms of alternative investment. Returns on mainstream equities have been negative, so they need to scour the market for different ways to generate growth.
Peter Norman, CEO of Sweden’s seventh national pension fund AP7, says his fund’s attitude towards private equity investment is still positive. “We didn’t put that much emphasis on it, but we included private equity in our ALM strategic studies. According to that, a 4% share of the portfolio was appropriate,” he says.
In early autumn the fund allocated $84m (E77m) to two US-based private equity fund of fund managers – Hamilton Lane Advisors and HarbourVest Partners. AP7 says it strongly believes this would generate additional capital growth for its savers.
Hamilton Lane is managing a US private equity fund of fund portfolio balanced between buyout, venture and special situation funds. One of the HarbourVest funds of funds, which AP7 committed capital to, invests mainly in European private equity funds while the other holds primarily US funds.
“Since we are just looking for one or two managers, we thought they should be very broad-based. We wanted to achieve the diversification,” says Norman. The investments are diversified across geographical regions, vintage years and stages, he adds.
Sweden’s other national pension funds have made new moves into private equity over the last 12 months. In late summer, AP6, the Swedish national fund that specialises in private equity, launched a new company to invest in seed capital in high tech companies in the Nordic region. The new company, Creandum, was launched in
conjunction with Skandia Life. AP6 already had Sek11bn (E1.2bn) of its Sek17bn capital committed to private equity, but hardly any of this had been in early stage private equity. Creandum will not finance projects, but instead work with universities and research institutes in the very early stage financing of companies.
Leaning more heavily on private equity to generate extra returns comes more naturally to the Scandinavians than it does to other Europeans, argues Mats Langensjo, executive director at Goldman Sachs Asset Management. He points out that private equity investment in the Nordic region has a very strong historic platform.
“Pension funds have been very active in private equity for a long time, even if it has been limited to just a few companies,” he says. Because of this history, there is no great shift required for pension funds when they begin using other vehicles such as funds of funds, to gain exposure to the investment type – it is a natural progression.

Need for diversification
However, while institutions in Scandanavia have been involved with private equity, this has tended to be quite limited, says Langensjo. The companies they have backed have been domestic businesses, and heavily biased towards certain industrial sectors, particularly IT/Telecom and biotech, he says.
Institutions and advisers are now very aware of the need for diversification, and so this concentration is now under review. “There is a reshuffling which they need to do, and which they are doing,” he says.
Traditionally, when institutions in Sweden and Norway invested in private equity, it was in individual companies with whom they became quite involved. Of course this close contact cost money. Now, pension funds are aiming to avoid that level of involvement but still get the returns that the asset class can provide, says Langensjo. Private equity funds of funds are seen as the solution.
“Historically, there were lots of specific risks. Many investors didn't really have a sensible level of allocation. And even if they had just 1%, this took up a lot of management time but didn't have much impact on return.
One reason why pension funds in Scandinavia are now particularly interested in private equity is – as elsewhere – because it can diversify their equity portfolio as a whole. “There are different return characteristics compared to public equity, and hopefully positive ones,” says Langensjo. “They are really looking to find access to a less efficient part of the market. In general people tend to look at anything that can do something different to the portfolio.” Pension funds are faced with lower return expectations from their public equity holdings, but very few have changed their return targets.
So for pension funds, private equity is simply seen as just another way – along with hedge funds and increased risk on the bond side – of getting more juice out of the portfolio, says Langensjo.
Pension funds that have moved into private equity commitments in the last few years – mostly the medium to large funds – are sticking with them, by and large, because they know it is a long-term asset class, says Steen Villemoes, Nordic representative of private equity advisory firm Altius Associates.
Pension funds in Scandinavia would typically have between 3% and 5% of their portfolios exposed, or as target exposures, to private equity, he says. Most pension funds that hold private equity are still in the build-up phase, though some have held back recently.
This has less to do with wariness of buying into the market than the simple inability to do so. Solvency has become a problem for the funds. Last year, many of them experienced negative or zero returns, even though their liabilities still had to be met. In Denmark, for instance, says Villemoes, relative equity exposure of pension funds halved from typically around 40% to 20% or even less, with some of the major institutions only having between 10% and 15%.
“But the larger funds are still plugging away with their private equity investment, albeit perhaps at a lower pace right now,” says Villemoes. “The areas most in demand are definitely the buyout funds. Many of the pension funds are looking to diversify their exposure internationally. There has been a local bias, historically, but they now acknowledge they need to have international diversification.”
While many investment professionals agree that in principle, pension funds should have private equity exposure, after three years of negative equity performance it can be hard for funds to convince their boards to make the commitment, says Villemoes.

Strategic not tactical
Even though the broad market is weak, Villemoes says there is enough activity and demand in the private equity market for the most experienced players. “It is not something one should try to time or fine tune, because that is not do-able. Private equity should be considered as a strategic rather than a potential tactical asset class. It is a matter of whether a fund will decrease its current commitment in one particular year.”
Among alternative investments, it was hedge funds that received most attention from pension funds last year, rather than private equity, says Jan Bernhard Waage, investment consultant at Wassum in Stockholm. The year before, however, there were several new private equity commitments made by pension funds in Scandinavia.
“Though there is still quite a lot of interest, hedge funds took over the alternative part of the portfolios last year,” he says.
However, one change over the last two years, says Waage, is that private equity has started to be classified as a regular part of the equity portfolio rather than as an alternative equity strategy.
Private equity holdings at pension funds in some cases appear to have increased recently. But closer inspection reveals an indirect explanation for this, he says.
Quite a few pension funds and other institutions have been forced to reduce their overall equity exposure, he says. In the main, they have had to sell their most liquid stocks to achieve this reduction. “This has made the allocation to private equity bigger than it has been in the past,” says Waage.

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