General partners look to continental Europe for new capital

01 April 2003

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Initiative Europeâ€™s Institutional Barometer confirmed that institutional appetite for private equity is growing. According to research carried out in Q4 2002, in excess of 30% of institutions contacted are currently increasing their level of exposure to private equity or, in the case of new entrants, planning to gain exposure to the asset class over the next six to 12 months. This increased acceptance of the industry has been demonstrated by the steady growth of capital raised by European general partners, particularly during the period 1996-2000, and has been further bolstered by the competitive returns generated by European buyouts in that period.

Historically, general partners raising large buyout funds have looked to US institutions when fundraising. This is apparent from Initiative Europe figures, which show that US institutions provided an aggregate 61% of the capital raised by EUR 1bn+ funds in 2001, compared with 28% provided by UK and continental European institutions. In fact, the growing appetite for European buyout investment by US institutional investors is highlighted in the Goldman Sachs/Frank Russell report 'Alternative Investing for Tax-exempt Organisations-2001', which states that US tax-exempt institutions have increased their commitments to international private equity from an average of 6% of their portfolios in 1995 to 17% in 2001.

The majority of this allocation has been channelled into western Europe: in 2001, the proportion of the allocation committed to western Europe by US tax-exempt institutions stood at 62%, slightly lower than the 70% peak in 1999. Yet many US institutions are currently over-allocated to private equity as a result of falling equities markets. In fact, some may have to sell part of their private equity investments in order to return to their original target allocation. In light of this change in the fortunes of US institutions, general partners hoping to fundraise in the future are increasingly likely to look to UK and European institutions for capital.

According to Paul Myners speaking at last year's EVCA Institutional Conference, the UK supply of capital looks set to level off in the near future following the de-risking of UK pension funds due to maturing schemes, the end of final salary schemes and the introduction of new accounting standards (FRS 17). The Goldman Sachs and Frank Russell report confirms this theory: in 2001, the proportion of UK institutional capital flowing into domestic funds fell to 57% of commitments, as institutions turned their attention to opportunities in non-domestic markets. This figure also reflects the transition undergone by private equity groups previously focused on the UK, such as Alchemy Partners, to groups with a pan-European outlook. Yet, general partners planning to raise funds will be relieved to know that there are signs of a reversal of this trend in continental Europe, largely due to the growing maturity of the institutional market. The booming fundraising climate in 1997-2001 saw increasing amounts of capital raised for European private equity from European institutional investors.

This can be attributed, in part, to continued increases in the strategic asset allocations of European tax-exempt institutions to private equity, which, according to the Goldman Sachs and Frank Russell report, grew from 1.9% in 1996 to 3.6% in 2001, with the average asset allocation for the UK and continental Europe falling to 3.7% and 3.4% respectively. The report also predicts that the strategic asset allocation will grow again in 2003 to an average of 4.3% (4.2% for the UK and 4.5% for continental Europe). EVCA figures show that capital raised from European institutions and the proportional contribution of this capital to total annual fundraising has consistently outstripped any other source of capital to the market.

Furthermore, institutions that have historically invested in domestic private equity products are now seeking to build more diversified fund portfolios and increase their exposure to the asset class. According to the Goldman Sachs and Frank Russell report, institutions in the UK market have sought to increase the regional diversification of their private equity asset allocations after previously committing the bulk of their assets to domestic vehicles. The report demonstrates that western European private equity received the lion's share of UK assets in 1999, attracting 84% of total tax-exempt institutional commitments. In addition, European institutions' recent exposure to the asset class indicates that there is room for their target allocation to grow. Countries such as France, Germany, Spain and Italy, which have little in terms of private pension fund provisions, are expected to provide a new source of capital for private equity fundraising once vital legislation is passed and private pension schemes come into existence. In fact, a recent article published by eFinancial news has estimated that as much as EUR 12-14bn of assets could be freed once the Italian parliament passes pensions legislation in May 2003.

Despite the current depressed fundraising market, the long-term prospects for the private equity asset class are encouraging. Fundraising has become more sophisticated and institutions are more aware of the asset class than ever before. Even traditionally slow-moving legislation is showing signs of catching up with the requirements of the industry. There is little doubt that the growing maturity of the private equity industry which has attracted more capital over the past few years, will have a significant impact on the amount of capital that general partners are able to raise. General partners should therefore make the most of the relatively untapped sources of capital to be raised and focus on building relationships with European institutions.

If you wish to learn more about the Institutional Barometer or the Review of Insitituional Investors please contact Sergio Jovele at Initiative Europe Ltd, email: sergio.jovele@initiative-europe.com, Tel: +44 1737 784 209