Private equity – Feature
which houses a combination of investments in primary funds and co investments. The LGPS pool has also launched another strategy, which closed to fundraising in January. The fund aims to deploy about 80% of its capital to the mid-market and below focusing on the lower end of the growth market. Portfolio man- agers will concentrate on sector focused funds and steer away from generalist funds, based on the premise that the former will be more effective in value creation. Border to Coast has also been active in private markets for some time, having committed £10bn since 2019. As part of its private equity strategy, it is invested in growth, special situa- tions and emerging market funds among others. For Chris- tian Dobson, private equity portfolio manager at Border to Coast, the lifecycle of the scheme plays an important part in selecting a private equity manager. He shares LGPS Central’s view that lower- and mid-level managers can offer better value creation. But for more mature funds, the ability to cash in may be the priority.
“If you are approaching a position where you may need liquid- ity in your private markets portfolio, that may encourage you to go to the larger funds where there is a better secondary mar- ket,” Dobson says. Similarly, Local Pensions Partnership has been invested in private equity for some time. The pool launched its private equity fund in 2017, and, as of 2021, it holds £1.6n in assets which are allocated across buyout, growth capital, special situations and distressed assets.
Turning point for DC
In contrast, DC funds have historically been cautious to invest in private markets, despite the favourable demographic of their membership and a rapid growth in assets. The fee structure and daily pricing requirements have so far been an obstacle. For Brian Kilpatrick, chief investment officer of the HSBC UK Pension Scheme, accessing private markets for the DC side of its scheme remains a research issue. For Kilpatrick, inter-gen- erational fairness is also a key concern because the J curve in private equity means that returns may initially be negative for a few years. “You can imagine a situation where the J curve will have a negative impact for members who are invested in the early years but retire before the investment returns are re- alised. Other members are there for the lifespan of these as- sets and then reap the rewards at the end. So, the question is, how do you build these assets in to your portfolio whilst trying to mitigate those different return impacts on different mem- bers?” he says. But even in DC land, things are changing rapidly. Nest, the £24bn master trust, awarded a £1.5bn private equity mandate to Schroders in May, to be deployed over the next five years. This may not seem like a large sum, compared to the amounts some DB schemes are investing. But over the longer term, the
master trust, which predicts it will have £100bn in AUM by the end of the decade, plans to allocate 5% of its rapidly growing assets to private equity. Nest’s chief investment officer, Mark Fawcett, argues that this mandate is indicative of how far DC funds have come. “Many UK workers, for the first time in their lives, will now have the chance to benefit from investing in private equity. We have never accepted that any type of investment is out-of-reach for our members. We want every tool in our toolbox to boost the risk-adjusted returns for our members.” Just like the LGPS pools, Nest is targeting the lower end of the growth market. “What we were looking for was a manager who is looking for fast growing smaller companies who needed more capital to buy out the entrepreneurs who set it up, or just to give them more capital so they can grow. So, this is not about big LBOs, who won’t be investing in Twitter or Asda, this is to drive growth for smaller companies around the world where there are investment opportunities we just cannot get on the listed markets.” He is optimistic that other DC funds will follow suit, arguing that this mandate could be a “watershed moment” for private equity to become more accessible to pension savers across the country. While Schroders did not want to name names, it con- firmed that it is currently in discussions with other DC schemes for private equity mandates.
Approach with caution Fawcett’s optimism will be music to the ears of UK policymak- ers hoping to bolster institutional investment in private mar- kets. But there are good reasons to approach these assets with caution. Strong investor demand means that GPs are forced to bid high to win auctions, which could lock investors in less favourable terms.
The market vintage could play a key role in future returns, as a report conducted by the European Central Bank argues. “Mar- ket exuberance can drive over-optimistic investments that may lead to low returns in the medium term: the worst-performing vintages are those of 2005-06, prior to the onset of the global financial crisis, as they deployed most of their funds at a time when valuations were highest,” it said.
The central bank highlights that private equity investments can also have detrimental effects in financial stability. “PE-con- trolled companies issuing leveraged loans had been driving corporate leverage higher and investor protection lower in the US and Europe,” the ECB warns. For Morrison, private equity still has much to offer but good research is key. “The risks when there’s a lot of dry powder out there is that there are lots of people chasing you for money, and it’s being able to get deep into that data and understand what’s a good sales pitch and what’s a good investment strategy,” she says.
Issue 114 | June 2022 | portfolio institutional | 49
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