May 20, 2014
Interviewed by: David Snow
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Pensions and Private Equity

Adveq’s Sven Lidén tells Privcap about recent research by the London Business School supported by Adveq, which examines what influences pension fund allocations have on private equity.

Adveq’s Sven Lidén tells Privcap about recent research by the London Business School supported by Adveq, which examines what influences pension fund allocations have on private equity.

Pensions and Private Equity

With Sven Lidén of Adveq

David Snow, Privcap:

We’re very pleased to be joined today by Sven Liden of Adveq.  You’re the CEO of Adveq based in Zurich, Switzerland.  Welcome to Privcap, Sven.

The title of the study is “The Extent and Evolution Funds, Private Equity Allocations.” You’re doing it in collaboration with the London Business School and the Coller Institute. It’s all about the role pension funds play in global private equity. You have some very interesting findings that I’d like to talk about. First, could you set the stage and talk about why you felt it was so important to better understand the role of pension funds in private equity?

Sven Lidén, Adveq:

To us, it’s always essential, because that’s our largest chunk of our clients. Most of our clients are pension funds. We also have insurance companies, but we only work for institutions. We wanted to understand a bit what happens on their side. Also, we have to say that the topics of this research are actually driven by the London Business School, not by us. They picked the subject because they thought there were no good studies on the topic.

Snow: It’s safe to say that pension funds, not only for your firm but for global private equity, are a huge contributor of capital; they are probably the biggest single source of capital.

Lidén: Exactly. Yes.

Snow: Are there questions around what the future role might be?

Lidén: There are many questions around that and they are a bit different because they’re different from location to location. You have to look at the different geographies. One interesting thing that popped up around this study, which is not prominent in the study, is that age development is one thing, obviously.

In Europe now, pension funds are quite ripe. They start to pay out more than they get, which means they are less inclined to do long-term investments, which actually would not help the private equity industry because they need the money now. That is one trend.

The other thing you’re seeing is the switch from the defined benefits to defined contribution, which also is actually working against the private equity industry. Still, we are seeing the allocation of the private equity growing and that’s because the push for returns is tougher than ever.

Snow: Let’s talk about returns. One of the findings of your report or your research is that, broadly speaking, pension funds with larger allocations to private equity tended to outperform by about three percentage points. Is this a big deal? Why?

Lidén: I’m not sure it’s big deal. It’s partly historically driven, because the larger funds also have very good times when the leverage was the key driver of private equity returns; that helped a lot get allocated because they went to larger funds. The other thing is that, obviously, a lot of funds try to do this on their own and without the knowledge. If you are a small pension fund, you do a few investments, and you tend to have a bad performance, which is partly why people also are moving back into fund-of-fund solutions.

Snow: One of your findings was that among certain populations of pensions (and I’m guessing in Europe), the allocation to private equity remains stubbornly low and the average allocation among these pensions is something like 5.6%. Talk about how it got to that point and how hard is it going to be for that allocation to expand.

Lidén: It’s hard to say because the main driver of allocations to private equity today in the pension world—at least in Europe but also in Australia and most legal environments—is regulation. People are driven by regulation and they put as much private equity into their portfolio as they are allowed to. That’s why you’re seeing pension funds have such small allocations compared to family offices or estate funds, which have substantially more in private equity because they are freer in their allocations. That is what really drives the allocations. At the same time, you also tend to have some base effects. Because the private equity value is moving much slower than the equity value, if the equity markets go up, then the private equity allocation goes down. If the private equity markets go down, then the private equity allocation goes up. That’s an external factor you see as well.

Snow: Speaking of regulations, have you been in touch with the various regulatory bodies that oversee pensions in Europe? Are they aware of some positive benefits of private equity, like its historical performance?

Lidén: Absolutely. The supervision in most countries is very positive to private equity. That’s a global phenomenon. They see that it is a good return driver. They see the logic of having long-term investments in a long-term scheme, which is basically pension scheme. That is all there. The knowledge of the industry sometimes is low, so they don’t know to promote it. But I’m working with the European venture capitalization, for example, and you could see that the politicians I met there all want to increase private equity allocations in Europe but they don’t know how. At the same time, they regulate because they want to be careful about how money is allocated in pension funds, rightfully so. They hinder private equity because they see it as risky. The main problem here is the perception of private equity as being a lot riskier than other investments, but I don’t think that that’s the case.

Snow: Nevertheless, your study predicts that there will be significantly rising allocations to the private equity asset class. At the same time, there are worries that, in the U.S., probably among U.S. pensions, the biggest source of global private equity capital, the switch from defined benefit to defined contribution might be a drag on increasing amounts of capital. What do you think? How big a problem will that be?

Lidén: It’s a very long-term problem; it moves very slowly. I don’t think it’s a big problem. But the raise of allocations to private equity we’ve seen over the last 10 years, especially in the U.S., because you’re also having much higher allocation in Europe—that might come to a stop. We’re going to now see more of a freeze of the growth in the U.S., whereas Europe, as you said, still has a lot of growth potential. That’s  because, first, we see that the funds that have been reporting the private equity of the last 10 years have all doubled their allocation to private equity over these 10 years and we have a lot of new players in the market. There are a lot of new people investing in private equity and they still have to build their portfolios. There’s still an investment phase; it’s still the new commitments. You’re going to see still quite substantial growth in Europe.

Snow: What are some other important findings from the study that surprised you or maybe confirmed a theory you already had?

Lidén: The most positive we saw is that, even for large pension funds, it makes a lot of sense to have a fund-of-fund allocation for niches, for things that can’t cover themselves, or for geographies that don’t want to cover themselves. To me, the surprise was to see that the large funds already have that, 15% to 20% of their allocation still goes through fund of funds, part of it historical, but part of the new allocation. To me, that was a very positive and surprising finding.

Snow: Clearly, private equity is a younger asset class compared to other asset classes. Therefore, there’s just not as much known about it. Do you think the level of transparency or understanding of how private equity behaves has been an impediment to its growth or its adoption by other types of investors?

Lidén: Absolutely. The lack of transparency that was there actually has been solved by now. Nearly everybody now in the industry has become quite transparent; I think the issue is going away. But the perception by regulators (or even investors sometimes), is that it’s still very difficult to get any kind of transparency and that clearly hinders the growth.

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