Private equity perfect for pension funds, says Covip's Rinaldi

Amy King: How would you describe the relationship between private equity and pension funds?

Ambrogio Rinaldi: There is a growing interest in private equity among pension funds internationally, which comes from several forces. The first is that the landscape for traditional investments is difficult both for bonds and fixed income securities; the prospect of low interest rates is long-term, we can't see when it will change. Secondly, prices for liquid equity have recovered a lot since the crisis, so they may not be expected to increase much more. So there is rising interest in alternative investments.

Private equity is very consistent with the objectives of pension funds, which should really have a long-term view. They can exploit the illiquidity premium, too. So when there is an illiquid asset class with a prospect of increasing value in the medium- to long-term, that is perfect for pension funds since they are not subject to liquidity crises (such as banking runs). So you can really have significant commitments to illiquid investments, as long as they have a higher return. So in general terms, the relationship between pension funds and private equity is very natural.

AK: And yet, despite the alignment, pension funds' allocation to private equity in Italy is extremely low. Why is that?

AR: In some countries, pension funds have a long tradition of allocation to private equity. However, there are other countries where that relationship is not yet mature, and one such country is Italy. The new kind of pension funds have a history that goes back to the late 90s, so we have about 15 years' experience but there is almost nothing in terms of private equity, for several reasons.

The main reason is pension fund administrators in Italy have had difficulty entering the private equity market because they are concerned with measuring the value of their investments mark-to-market on a continuous basis and with short-term performance. This is for several reasons, some of which are well-founded and positive in principle such as the need for transparency and communication with members. This has meant traditional investments, in bonds and listed equity, fitted their purpose better.

There were also elements of regulation that encouraged and reinforced this tendency, including the need to compare the return on investment to benchmarks – a major feature of Italian regulation. So all this pushed in one direction. We have to recognise as well that this led to quite positive results in terms of returns, even during the financial crisis of 2008-2009, when Italian pension funds, because of their comparatively conservative attitude and asset allocation, were able to defend the value of their investments quite well. There has not been much reason for them to look for different investment strategies, but I think that now things may change. New regulation will encourage re-thinking the asset allocation and will soften the requirements to compare investment with benchmarks.

AK: Is remuneration within pension funds linked to returns generated on investment?

AR: The majority of Italian pension funds, and all the "new" ones that are allowed to grow and get new members, have to appoint a professional asset manager. So the actual investment choices cannot be made by pension fund administrators; they have to appoint an asset manager

As far as asset managers are concerned, the fees that define the mandates are not linked to performance. The mandates themselves define whether or not a fund can commit to private equity, and in most cases they cannot. When awareness of the need to diversify a portfolio increases, I expect Italian pension funds to develop a mandate to invest a small portion in private equity.

AK: How much private equity expertise is there at pension fund managers? Does Italy need professionals with more experience of private equity within pension funds?

AR: Of course, in order to give a mandate in one specific asset class you have to be confident about the characteristics of the asset class. We need to develop that culture; at the moment, there is not much expertise.

AK: Could hybrid instruments, such as convertible bonds for example, play an important first step in boosting pension funds' exposure to the asset class?

AR: It is possible, but I am not sure if there is a need for an interim step, with pension funds first developing experience of convertible bonds and then developing experience of private equity. I think experience of private equity can probably come straight away. When you have structured instruments like convertible bonds, sometimes it gets even more complicated.

AK: What could the private equity industry do to attract more investment from pension funds?

Cost is an issue. We know sometimes costs for this kind of instrument are really high and we really want pension funds to be careful in terms of the costs of investment. We know that is a very sensitive issue, and we also know that when costs are high you might have a higher gross return, but net return is what is important for members. To facilitate more investment from pension funds, private equity needs to develop instruments that have comparatively low costs and can be more easily accepted by pension fund administrators as value for money.

Ambrogio Rinaldi, Central Director, Covip – Pension Funds Supervision Commission, will be speaking at the unquote" Italia Private Equity Forum, taking place on 12 November at the Four Seasons Hotael in Milan. Click here to find out more about the event and to book your place.

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