Although throughout Europe pension funds are looking more towards private equity investment, they are virtually going it alone because there is little infrastructure available to advise them about where to put their money.
Throughout Europe, investors are being drawn to private equity because of the potentially higher returns, particularly in light of decreasing returns on equities and bonds. Some are jumping into the private equity market without completely understanding how it operates, and getting disappointed – or sometimes getting burned.
Like other alternative asset classes, it takes some digging to find the best investment opportunities. Few funds have the research resources available to go into the market directly. The next stage is to invest through a ‘gatekeeper’. But the safest route is to go through funds of funds, which may add a second layer of management fees but offers less risk.
However, even relying on intermediaries is not clear-cut; the quality of information is variable, and few managers have been in the market themselves for long enough to establish a long-term track record. Great results during the 1990s bull market also sometimes paint extremely rosy pictures, which might obscure where long-term results are available. And with private equity, even more so than with many other investment classes, it is the long term that counts.
“It is easy to be schmoozed and bamboozled by the numbers,” warns Jonny Maxwell, chief executive of Standard Life Investments Private Equity. “It is a very complex asset class, and you cannot do it part-time.”
On the European scene, the UK market for private equity is the most developed, and has been given even more impetus following the Myners Report. Interest is steadily growing, according the British Venture Capital Association (BVCA). “What we have seen over the last few years is that more and more UK pension funds and their advisers are looking more frequently and favourably at private equity,” says John Mackie, chief executive of the BVCA. “And for 2001, I am told that a significant number of pension funds either increased their existing allocation to private equity, or made an allocation for the first time.” (The definitive BVCA figures for investment in 2001 are not available until May.) But even here, “it is an area where there is a paucity of hard information,” he continues.
The major firms of consulting actuaries in the UK are known to have been doing their research on the private equity market, but it is still early days.
“If you compare the UK and the US there is a stark contrast,” says Chris Davison, head of research at AltAssets, part of Almeida Capital. “It’s as much a factor of history as anything.” But Davison also pointed out that there are efforts on a lot of levels to
rectify the situation – from the BVCA, from investors and from consultants. “Since last year, there are signs that things are starting to change, at least on a fairly simple and limited level,” he maintains.
He is not alone in noticing signs of change. “Almost all the consultant actuaries are making a serious effort,” says Maxwell of Standard Life. “Some started years ago, so the quality of experience is very varied.”
The fact that the advisory platform is not totally geared up this year affects the development of the private equity market, limiting its growth both in terms of size and depth. “Where there is less experience, they tend to follow safer brands rather than the best performers. Its the ‘nobody got fired for buying IBM’ mentality,” says Maxwell. “But the more enlightened of them are moving away from the one manager for the whole planet approach.”
Following a brand is particularly unsuited to private equity investment, in Maxwell’s opinion. “Track records belong to people, not houses. This is why buying brands does not necessarily work,” he explains. This is particularly true with investment banks, he maintains, because they have a tendency to take on people during the good times and let them go during the bad periods. The research process, therefore, has to be intensive and on-going.
Maxwell has been impressed with some of the consultants who have made site visits. “Some have made an effort to come to see us, not just for an hour or two but for a day or two,” he says. “They’ve learned what questions to ask, and how to identify statistical fudges.”
It will take some time to develop the required level of expertise. In the short term. “They probably need to bring in people with genuine expertise and experience in the area,” surmises Chris Davison of AltAssets, “because there is not a lot of homegrown expertise.” But homegrown expertise is what is needed. “We need and want European specialists in Europe,” maintains Maxwell.
While in the UK there is an embryonic advisory system developing, the same is not true on the continent. “If you are a fund of funds, then you are the adviser,” states Charles Soulignac of Fondinvest in Paris. “Few institutional investors use investment consultants here. A fund of funds is an indirect consultant.” And this is in France, which is the number two market for private equity after the UK.
In the Netherlands, the situation is much the same, according Lesley van Zutphen of the NeSBIC Group. “I suppose you can hire a consultant. But if you ask me for the name of a consultant for the Netherlands, I do not know one.”
Funds of funds also therefore play a major role in the Netherlands. “They are well-positioned to advise their clients, because they are very well informed about what is going on in the market,” says van Zutphen. “On a performance level, they are very well informed, and also in terms of how the structure of independent private equity funds works.”
Van Zutphen cautioned investors who want to get into the market directly. “Some of our direct investors did not receive enough advice on how the private equity business works. They do not have a formal private equity policy and did not completely understand. Those are the people who get a little nervous, because they do not understand the mechanism and the risks,” she says. She also points out that there is a big discrepancy in terms of knowledge base among European institutional investors. Those firms that do not have in-house expertise and a formal private equity policy either should try to find a professional advisor, or get into the market through a fund of funds, in her view.
Compared to direct investment in private equity, the benefit of the fund of funds approach is the diversity of investment base, according to Soulignac of Fondinvest. “A fund of funds is more diversified. A consultant can suggest two or three investment opportunities, but a fund of funds offers as many as 15 funds.”
But it is still down to the institutional investor to choose among all the funds of funds on offer, and in continental Europe, there is even less chance of getting any advice than there is in the UK. Soulignac offers three guidelines to help make that selection. Investors should look at the track record, choosing a manager that has a long and consistent proven track record, having managed a reasonable volume; the team should have been in place for a while, giving it an in-depth knowledge of the market; the manager should also have access to a wide range of funds and general partnerships, and be able to maintain good relations with the GPs.
The lack of a formal advisory structure may also be slowing the development of the private equity market throughout Europe. “In our last fund-raising, two years ago, we had to educate people. If they could use independent advisers it would make it a lot easier,” says van Zutphen of NeSBIC. “Also smaller pension funds could invest a little in private equity but not in a sustainable programme. This could be very beneficial for the industry.”

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