A survey of institutional investors in private equity funds

Each quarter, the RII research team surveys approximately 70 institutions to assess their appetite for investment in private equity. Research centres exclusively on European investors with existing exposure to the asset class or with plans to gain exposure over the next 12 months. 28% of those questioned this quarter were based in the UK. The Scandinavian markets provided 21% of respondents, with a further 7% coming from the Benelux region and 6% from Switzerland. The remainder was evenly split between Germany, France, Austria, Spain and Italy. This sample also included a Greek fund investor, a region not often represented within our surveys.

This quarter's sample of institutional investors included family offices (5%), fund-of-funds managers (5%), pension funds (55%), corporations (6%) and insurance companies (6%). The remaining 23% of respondents were made up of other financial institutions including asset management firms, charities, investment companies, banks and government bodies.

The RII research team has spoken with 14 institutions considering the introduction of a formal allocation to private equity. This figure accounts for 17% of our sample (up on 11% six months ago). The encouraging number of newcomers to the asset class remains a positive indication of growing confidence in and understanding of the industry.

While some groups continue to invest on an ad-hoc basis, only carrying out investments when particularly attractive opportunities arise, it is clear that the balance is shifting towards using a more formalised strategy. 52% of respondents indicated that a formal allocation for investment in private equity is in place, while a further 17% of institutions questioned are currently considering the introduction of a formal allocation to private equity having had no previous experience of the asset class. These groups will have a defined target allocation and dedicated executives responsible for investment in the asset class. An opportunistic approach remains evident amongst investors exiting the market. Although not actively seeking further investment opportunities, these groups may consider investing if a particularly attractive opportunity presents itself or if a certain manager begins fundraising. Groups making a first foray into private equity also often favour the opportunistic approach, with a number of local authority pension schemes investing on this basis.

As reported in the last barometer, a high number of smaller institutions are using external consultants to advise on initial forays in private equity and some, including Hampshire County Council Pension Fund, are rejecting the recommendations made. This local authority was recently advised to invest up to 10% in alternative assets, but could not be persuaded that the risk/reward profile was attractive enough.

A total of 8% of our sample stated that they were decreasing their private equity investment levels or exiting the market altogether. From the conversations held with these institutions, it is evident that the recent economic climate is often responsible for these changes in strategy. With the fall in equity markets taking its toll, many investors such as Svenska Handelsbanken, have found themselves over-committed to alternative assets as the value of their equities portfolio diminishes. Other institutions have found it necessary to increase their target allocations to the asset class to compensate for these developments. With many institutions facing these pressures, the effects are likely to be substantial, at least in the short term, for general partners currently raising capital.

Analysis of the data collected reveals that 13% of institutions questioned are looking to invest exclusively or mainly via fund-of-funds vehicles, compared with 12% last quarter. As would be expected, these respondents were primarily pension funds, including a number of local authority schemes, which often state resource issues or lack of experience in the asset class as the reasoning behind this strategy. Other institutions will only invest via these vehicles to gain specialist expertise required for a particular market or to gain access to a particular geographic region. The majority of those planning to enter the asset class over the next 12 months expect fund-of-funds vehicles to be the likely route. A smaller number of institutions, such as Aberdeen City Council Superannuation Fund and a number of governmental bodies in Scandinavia, invest in private equity funds exclusively through one chosen fund manager. This approach requires less in-house research resources but limits the number of opportunities available to investors. Once an institution has established a relationship with a management team, it is often inclined to maintain it. The range of commitments recently secured for Accent Equity Partners 2003 demonstrates this point with many of the investors having backed previous funds of Nordico and Euroventures.

For pension funds that provided details of a formal allocation to the asset class, 2.9% of total assets was the average investment target. Although down on the average 3.4% reported last quarter, this still compares positively with the 1.5% and 2.3% reported in the previous two periods. Insurance companies involved in the survey also reported an average 2.9% allocation to private equity. As would be expected, no precise figures were available from the sample of family offices but it is understood that they plan to remain active within the asset class whether through European or US offices.

Research has revealed that the positive trends identified in recent barometers continue to be evident. With 20% of the experienced investors within our sample stating an intention to increase allocation or activity levels in the near future, and the high number of new entrants to the asset class, many private equity fundraising professionals may find some relief in the long-term institutional appetite for the asset class.

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