Pension funds failing to stick up for private equity

Pension funds have historically been one of the most substantial investors in private equity funds, even though the asset class makes up a relatively small part of their total allocations. ABP, the largest pension fund in the Netherlands, for example, allocates only 5.3% of its €274bn of available assets under management to private equity. Alternatives help to balance investment portfolios, spread risk and increase returns.

Private equity fills a natural funding gap for small and medium-sized companies that require external capital other than traditional bank loans. In today's economic climate, reviving SME growth and providing a fruitful environment for funding alternatives is close to the heart of every administration.

Yet, neither pension funds nor governments seem particularly keen on speaking out in favour of private equity, leaving the industry with perpetually bad publicity and an image of a job-destroying bad boy. Only recently, some critical voices supporting private equity have become louder.

"Everybody in the OECD is in private equity through their pension funds. That fund manager who makes money off carried interest is the one who fills the gap in your pension funds, making retirement possible. That's why pension funds need to be outspoken about how necessary private equity is as an industry," says Francesco di Valmarana, partner at Pantheon.

In the post-Lehman world, traditional investments do not have the appeal they used to have. Alternative investments have a strong selling point as they offer something different from mainstream asset classes. But new regulation that has been proposed and partly introduced since the 2008/2009 crisis is counteracting this. Suddenly, private equity, and distantly related hedge funds, was viewed as part of the shadow banking system that would destabilise financial markets and add to systemic risk. Under a number of regulatory proposals, the marketing of private equity funds would become more difficult and it will become more problematic for some institutional investors to commit.

"Politicians say one thing in public, but they really know how important private equity is," claims Marie Reinius, CEO of the Swedish Venture Capital Association (picture). Admittedly, with every deal that goes wrong, critics get more ammunition. "Although there were scandals in some sectors, like healthcare, politicians know that private equity firms own companies across many sectors and what value it brings to the society."

Although Europe's Nordic region has been a popular deal destination in the recent past, the Swedish and Danish regulatory landscapes are not exactly private equity-friendly, a situation that has worsened recently. For years, the topic of carried interest taxation has been a heated debate. On the flipside, 7% of Sweden's working population in the private sector is employed by private equity-backed companies and 30% of the country's foreign direct investments are private equity-related. And these are not the only favourable arguments says Reinius: "Sweden has a lot of old infrastructure in place that will need to be replaced. And who is going to pay for that? The tax payer? Private equity would be an interesting source of investment."

Overall, private equity should have a better reputation by default. Despite deals gone wrong, the industry provides a range of valuable services that benefit a large number of people as opposed to just the C-suite. Europe's pension funds are facing a funding dilemma, the gravity of which is increasing as demographic changes move Europe towards an ever ageing population. Denying a profit source seems counterintuitive. For regulators, denying them to invest in profitable ventures seems even more detrimental.

"The private equity industry has been successful and earned a lot of money – and so have the pension funds. Because it is the money people have been saving for their pension that is invested in private equity, we should all hope for good returns," Reinius concludes.

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