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Private equity: the long road to acceptance

Editorial: Institutions are undoubtedly becoming more interested in private equity as an asset class, but the industry and the funds themselves still have much to do to allay their fears.

If it's a tough time to be raising funds right now, it's not for a lack of interest among institutional investors. A glance down the delegate list of this week's Alternative Investment Summit (day two was devoted to private equity) shows many of the familiar institutional names who have been investing in the asset class for quite some time. However, it also lists a number of new faces - people who are keen to learn more about private equity to assess whether it's an appropriate asset class for their institution to invest in.

There's no doubt that the interest is there. Whether that's down to the Myners Review, the BVCA's working group with the NAPF or  some other reason, it has to be a positive sign for the industry.

What isn't so positive is the fact that, even after a whole day of slides highlighting performance figures, returns to investors, growth of the industry - the list goes on - many investors new to private equity still had nagging doubts. The main reasons? What they perceived to be a lack of transparency about performance figures and the high fees involved. Not that surprising, but it points to the fact that there is still much to be done to encourage new investors to look below the surface.

That the speakers were able to present a wealth of data on private equity shows that the industry has made great strides in recent years. The EVCA and BVCA figures compiled in conjunction with PricewaterhouseCoopers are the main European numbers. But there are others out there that show different results, such as those provided by London Business School and Venture Economics. As Kerrin Rosenberg of Bacon & Woodrow pointed out, performance figures are only valid over long periods of time, they are not always net of all fees and their coverage can be patchy.

They are also open to interpretation. Even the chairman for the day, John McCrory, chief executive of Westport Private Equity, admitted as much after delegates had repeatedly asked questions about, and queried, performance results throughout the day. ‘Very few people in the industry, including the BVCA and the venture capitalists themselves, know how to interpret the returns figures.'

And then there are the fees - two per cent management and 20 per cent carried interest, in general. Fees are ‘enormous' in private equity, said Rosenberg. ‘If you allocate the standard five per cent to private equity, the fees will be higher than the other 95 per cent of your portfolio put together.' As one local authority pension fund investment officer commented: ‘How on earth can I justify that level of fees to my board and trustees? They'll think I've gone mad.'

There's little that can be done about the fees. Institutions trying to invest in private equity on the cheap could well find, ten years down the line, that they have invested in dud funds. This means that more needs to be done to educate trustees on private equity generally, but in particular on why private equity can appear to be so costly.

On the subject of performance, it can only be healthy that institutions such as pension funds ask those difficult questions. True, you will never be able to compare private equity performance accurately with public equities. It's like comparing apples with pears. But there are clearly improvements to be made. Some believe that the flow of capital from US institutions (the largest single source of private equity money in Europe) may well slow over the coming years as economic conditions mean that they have less to invest. If this is so, then European firms will have to persuade European institutions that private equity is a viable asset class for them. To do this, they will have to start answering some of those difficult questions. That should mean the development of better and more comprehensive private equity data - including information from funds that have performed badly as well as those who have generated good returns – allowing investors to see which funds really do fall into the top quartile according to performance.

In the meantime, institutions that do manage to choose the top quartile funds, either themselves or via fund of funds, will see the kind of returns they need to satisfy their boards. Even Rosenberg, who was the most direct about a lack of transparency in the industry, said that there were very few pension funds that should definitely avoid private equity - and those were ones run by companies in financial difficulty or that were themselves insolvent. Add to that the fact that the local authority pension fund investment officer was still determined to find out more on the subject and potentially persuade his trustees that he hadn't gone mad can only mean that the current interest in private equity will not be completely dampened by some nagging doubts.

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