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Investor profile: Stuart Imeson, head of pensions and investments, West Yorkshire Pension Fund

With £5bn of assets, the West Yorkshire Pension Fund is one of the UK's largest local authority funds. After investing small amounts in private equity since the early nineties, it has recently decided to increase its allocation to two per cent by investing in specially created funds, other funds and fund of funds. And, should these investments perform well, there is every chance of that allocation increasing.

How did you start investing in private equity?
‘Until recently, we used privatE equity as a means of supporting the local economy. Before we decided to increase our private equity investments, our main exposure was through a couple of bespoke funds that we'd raised ourselves - two £15m funds. One raised in 1992, another in 1997, where we invited applications of interest for somebody to manage the funds in the north of England on the basis that if the offices were based in the north, then it would capture some of the northern investments. Through that, we appointed what is now Bridgepoint Capital. We appointed the firm in 1992 to manage the £15m fund from their Leeds office. That was fully drawn down and invested. It did spectacularly well. It invested the £15m across 20 to 21 companies. Not one of those companies has gone down. 14 of those have been realised.

‘On the back of that excellent performance, we then appointed Bridgepoint to manage another £15m fund. We widened that a little to include their Manchester office. That's about 50 per cent drawn down now. There have been a couple of realisations already.

‘So really, it was the local aspect that attracted us initially and it's now on the success of those funds that we've all seen that if you invest in the right fund with the right managers, you can get some good returns. That has been the driving force behind it. We wanted to get some money working locally and it's from that base and the excellent performance that we've had from them that we're moving into the bigger picture. Ask any local authority why they are investing in private equity and a good proportion will say that they want to support the local economy.'

Why did you decide to increase your allocation to private equity?
‘The way we look at it is that, especially with markets the way they are at the moment, although private equity is perceived as higher risk, if you look at the average returns from private equity, you're looking at 18 per cent returns. That's a good six per cent above what you'd get in equity markets. Within that 18 per cent, you've got some that are reaching up to 60 per cent. If you get to the right managers, it can add some real value to the portfolio. It's a good edge compared to some of the other asset classes, especially at the moment.'

How did you decide where to allocate the money?
‘We said we'd invest £120m in private equity. The panel decided to break that down into three geographical areas. We wanted 20 per cent to go into regional and local funds, 50 per cent into the rest of the UK/Continental Europe, and the rest into the US and other global markets. Within that, we said we would like to see a mixture of funds that invest directly and some that do fund of funds. We wanted to cap the exposure to any one particular manager, so that we'd have no more than 30 per cent of the £120m with one manager. We also wanted to restrict the amount that went into pure venture capital - the early-stage investing - to no more than 15 per cent.

‘With that strategy and those parameters, we went to see how we'd get the money into the market. We already had these two local funds, and then earlier in the year, to get up to the 20 per cent, we appointed Aberdeen Murray Johnstone to manage a third £15m local regional fund. We didn't go with Bridgepoint again because it has now launched two big pan-European funds and is no longer geared up to manage local funds.

‘Last year, we committed to Bridgepoint's first pan-European fund and we also committed earlier in the year to their second fund that they've closed now.

‘So we needed to invest another £63m. We wanted to invest it in fairly sizeable chunks of about £10m to £15m in about five funds. So we decided that we didn't need to fork out another layer of fees for a gatekeeper. The in-house team looked at a huge range of funds - around 30 - and pinpointed five that met the strategy and invited them up to a special meeting of our investment committee. We agreed then to invest across those five - some of them concentrating on Europe, some US, some global. Two of them were pure fund of funds, two pure direct investors and one was a mixture of the two - Habourvest, Goldman Sachs, JP Morgan, Barclays Capital and Schroders.

‘It will take a while before the money is drawn down but we've now got the two per cent committed. So we'll take a 12-month breathing space and have a look at things again then. If things go as well as they went with the local funds, there's every chance that we could push the allocation up another one to two per cent.'

They're all established and well known names that you have committed to….
‘Yes, they are big players in the market, are well established and have a long track record. But we also looked at the spread of investments. We went with Barclays, because of the areas that they were targeting - small to medium-sized companies; the JP Morgan fund is looking to go into much bigger deals. It was that kind of mixture, spread and diversification that we were looking for.'

What specifically do you look for in a good private equity manager?
The people, how long they have been in the organisation. Have these people created the track record? Or have those people moved on? What kind of due diligence processes do they go through. Where do they find their deals from? How do they get into the companies and once they've done that, what process do they go through before making the investment? But some of the best performing funds don't have to go out and find investors, investors have to go to them, so the fund of funds that we've chosen are managed by people who have a past history of being invested in some of the best funds. They have access to them. We also look for mangers that invest their own money in the fund so that their interests are aligned with ours. But after all that, you have to trust them to get on with it. If they produce the goods, then you'll invest in them again. If they don't then you won't.'

The Myners Review highlighted a lack of knowledge among trustees. How have yours taken to private equity investing?
‘The trustee panel now has more idea about private equity than it does about other asset classes because they have had to get up to speed on it. They've been to seminars, we've had training days and they've visited some of the managers. They've taken a keen interest in it. The other thing that has kept them well up to speed is that, since 1992, Bridgepoint has come to each of our quarterly meetings to give a progress report on how the fund is performing and on what they have invested in, etc. So they have a good feel for it and they know what it's all about. We're talking here about local councillors. They can see that the private equity investments that we've been making are seen to be supporting the local economy. Obviously, our primary aim is to get good returns, but there is a chance that what we're doing can help the local economy. So there's a keen interest there.'

Why do you think other local authorities pension funds have been slow to invest in the asset class?
‘Some of the smaller local authority funds are as low as £500,000. For them, it's a lot of work for a very small investment. That's one element. The other is the risk attached to it. I don't think that anyone would disagree that investing in unquoted companies means that you're reliant on a management team and there are a lot of things that can go wrong. So it's down to size of portfolio and risk type. However, look at the biggest local authority pension funds - the ones worth over £2bn. You'll find that most have a reasonable exposure to private equity.'

Would you ever invest directly?
‘It's unlikely mainly because we don't have the resources to do that. We'd need to hire new people to do a piece of dedicated work on private equity. It's a very intensive process. You hear private equity firms saying that they look at thousands of proposals every year and then invested in 21 of them. If you're going to be flooded out, you have to do a lot of work to make sure that you're in the right companies. We couldn't do that. Besides, it's a totally different skill set and it would be hard to find the right person who'd want to do this in West Yorkshire. Then there would be the issue of remuneration. A couple of local authorities have their own direct investments, but no more than that. They have managed to recruit people. But the time taken is so immense for the small amount you'd get.'

What advice would you give to a new investor?
‘You have to really understand how the investment works. It's a totally different type of investment from the ones most people are use to. It's a case of talking to people who've done it, to the fund managers and of reading a lot. Once you're in the investment, you're locked in so you can't just sell your way out of it. It's a long-term investment. You have to understand the upsides and downsides and then about the different types of vehicle that you can invest in. The main thing is to get over the initial perception that it's far too risky to bother with. You should consider it as a niche part of your portfolio in which you can add significant value. For example, there's a lot of fuss about hedge funds at the moment, but we're going to sit on the sidelines for at least another 12 months to see what happens. We want to get familiar with it and understand it, get a feel for how it all works. I think that's what you've got to do with private equity. Do a very small investment initially and then take it from there. We built up from a small start and have had a very steady learning curve over the years.'

What do you think are the main issues for the private equity industry at the moment?
‘What surprises me is the scope for development of the private equity industry. It is developing in Europe quite strongly and quickly. You've got a raft of firms setting up pan-European funds, whereas traditionally, you only really had funds investing in the US and the UK. I'd say the issue is making sure that there are enough good opportunities out there for all these funds to back. If there are 500 new funds a year, there has to be a market for those funds. Quite clearly, there is a danger that, because of the competition to get into the better opportunities, some of these funds might end up being second division ones. If you look at any statistics of the money going into private equity, it's increasing at a staggering rate. That can't be sustainable.'

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