Optimism as institutions foresee increases in allocations

08 August 2003

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For the second quarter Initiative Europe's institutional barometer estimates a total of EUR 338.3bn under institutional management; within this sample, the average managed by pension funds interviewed is EUR 8.1bn. Institutions questioned included family offices (4% of sample), funds-of-funds (15%), pension funds and insurance groups (65%) and other financial institutions such as banks, charities and government bodies (16%). These groups are based across Europe, with the UK and Nordic markets providing the bulk of those questioned (52% and 15% respectively). Interestingly, Iceland, where limited activity has taken place in the past, is becoming increasingly interested in the asset class. The Benelux and Switzerland each provided 10%, while Germany accounted for 7%; Austria, Ireland, France and Spain accounted for the remaining 6%.

From the conversations held over the past quarter with our sample of investors it has become clear that the distinction between family office and asset manager is becoming increasingly blurred. The 4% of groups that are classified as family offices in this quarter's sample manage investments in private equity for third parties in addition to the wealthy families they were originally set up to represent.

The reasons are usually two-fold: wealthy families intending to enter the private equity arena for the first time may prefer to deal with another family office, considering it to be more in tune with their own particular needs; and a family office with successful experience in investing in private equity, but which is less well recognised than many of the pension funds or insurance groups as a serious investor, may be in need of access to larger or more sought-after funds and benefit from increased funds under management.

This quarter's data includes one group that has a strong track record in investing in private equity both in Europe and the US and has a growing business area in structuring private label funds-of-funds to be managed by private banks.

Once again, we find that by far the largest proportion of investors interviewed have a formal allocation to private equity. This time, 68% (compared with 57% in Q4 2002 and 71% in Q1 2003) have a formal allocation in place; the percentage reaches 84% in the case of the pension funds questioned. A further 13% of all institutions questioned are about to establish a formal allocation to the asset class. None of those that do not have a formal allocation describe their own approach to private equity as 'opportunistic': those that do not have a formal policy have predominantly moved away from the asset class altogether (12%).

Questions arise about the European industry's ability to invest such large sums of capital in the current climate, although limited partners are well aware of the need on the part of general partners to select wisely even if this means that investors remain well below their target exposure in the medium term.

Information regarding the size of allocation for the majority that do have a formal policy varies for different investor types. Little detail is available for family offices, but where it is, as expected, allocations range from 10% to 15% of total assets. For pension funds, the average allocation to private equity is 3.4% of assets; this compares with 1.5% in Q1 2003 and 2.3% in Q4 2002.

While most pension funds' allocations are fairly close to the 3.4% average, Kodak Pension Fund in the UK stands out with an allocation of 10%. The British Coal Pension Fund in the UK, for example, has an unusually high 80% allocation to equities, incorporating a 3-4% allocation to private equity. Similarly, research carried out both in Q4 2002 and Q1 2003 found two corporate pension funds - Bank Pension in Denmark and NestlÃ© Pension Fund in Switzerland - each with a 7.5% allocation to private equity.

Encouragingly, close to half of the institutions questioned (44%) are planning to increase their allocations to private equity in the near future (compared with 16% in Q1 2003 and over 30% in Q4 2002). This quarter, the figure includes 9% that are already active; 16% that are about to begin investing; and 19%, principally made up of asset managers and funds-of-funds, which regard their allocation to be on the increase since their business is growing.

Overall, 77% of institutions questioned could be subjectively regarded as a good potential source of capital for fund managers seeking capital either now or in the medium term. This figure compares with nearly three-quarters of institutions contacted in Q4 2002 and 74% in Q1 2003. Even allowing for the fact that Initiative Europe's reasons for contacting our sample of institutions include anecdotal evidence that an institution may be entering the private equity arena or be about to change policy, the proportion of investors that have a strong appetite for the asset class is consistently high.

Of the 15% of institutions that have recently moved away from private equity, 7% have either been active on an ad hoc basis in the past and considered formalising their activity or have looked at introducing private equity into their asset allocation for the first time, but, ultimately, decided against investing.

Among the investors that have moved away from the asset class is the UK pension fund of the BMW group, formerly Rover Pension Fund, which no longer has an appetite for private equity due to its maturity. It is not known how many institutions consider private equity from time to time and, of those, what proportion then either decides to invest or rejects the asset class.

However, it appears that institutions with an initial interest in the asset class may be appointing external consultants to confirm their own considerations. In any case we have yet to find an investor who cites the use of one of the private equity specialist consultants and who has then gone on to reject the asset class outright.

In this quarter, only 12% of institutions questioned have opted to invest exclusively via a fund-of-funds vehicle, with a further 3% (18% in Q1 2003 and 11% in Q4 2002) investing via some other private label mandate. Institutions that have chosen to invest exclusively through fund-of-funds vehicles include Lancashire County Council Pension Fund in the UK, which channels all of its private equity fund investment activity through Westport. In Q1 2003, 16% of our sample invested exclusively through pooled vehicles, while, in Q4 2002, the figure was 16%.

It is interesting to note that pension funds, which make up a large proportion of the typical client-base of fund-of-fund managers, account for 65% of institutions questioned this quarter (compared with 56% and 63% of the previous two quarters), and that 16% of our sample is comprised of newcomers to the asset class.

Although it is undoubtedly premature to come to conclusions as to the future role of funds-of-funds, this data may indicate the beginning of a change in the way institutions use funds-of-funds, supporting general impressions that institutions are indeed more comfortable about making in-house selections at least in areas such as mid-market buyouts. Institutions continue to use funds-of-funds or other pooled vehicles in order to address particular aims, such as gaining access to a difficult sector, or, as in the case of one investor this quarter, as a means of quickly reaching a new, higher target allocation.

A quarter of the institutions sampled in Q2 2002 are seeking to build a diversified portfolio in terms of both stage and geographic focus. It is also encouraging to note that 7% of our sample are focusing mainly on early-stage investments, compared with none in the previous two quarters. Investors have been keeping a watchful eye over the technology sector for some time and evidence is beginning to emerge that interest in the venture area may be slowly returning.

Initiative Europe expects to take another look at Europe's institutional sector based on research for Review of Institutional Investors in three months' time. For more information about subscription to the Review of Institutional Investors, contact sergio.jovele@initiative-europe.com or telephone our offices on +44 1737 784 200.