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We have been advised to start investing in private equity with just a one per cent allocation. Isn't that a lot of extra work for a minimal difference in overall returns?05/12/2001. Source: Railways Pension Trustee Company. Peter Murray 
 From Peter Murray, chief executive, Railways Pension Trustee Company: No, because it makes sense to start with a small allocation and increase that gradually as you become more familiar with private equity.
The amount any investor allocates to private equity should depend on how experienced its people are in the asset class. It's a good idea for pension funds to take a reconnaissance approach by starting with a small allocation of around one or two per cent to the asset class and then build up gradually. Otherwise, if the fund is badly burned for any reason, then trustees will want to retreat and it would be hard to convince them to continue investing in private equity.
It's also worth bearing the J-curve pattern of returns in mind. Returns from private equity fund investments are negative for the first few years as money is drawn down by the firm and committed to companies. You may not see any cash back for three years in many cases. As a result, if you allocate too much to private equity, the pension fund's overall cash flow may be affected.
The other factor in this is the future performance of other asset classes. Historically, returns from public equities and bonds have been good or reasonable. Over the last 20 years, public equities have returned an average of 12 per cent net. The figure for bonds is eight per cent net. However, in the future, we're unlikely to see this level of performance from either. Bonds will produce no more that two per cent and equities will certainly be below 12 per cent.
In this type of environment, I would say that it makes sense to look at some of the higher return investments such as private equity even with very low allocations - if you can add another percentage point to single figure performance, then it is an attractive proposition.
The Railways Pension Trustee Company is responsible for the £16bn of the railways pension schemes.
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