European private equity allocations rise fast

Exceeding expectations, bullish European institutions have doubled their private equity commitments since 1999, allocating E27bn to the asset class in 2001.

European tax-exempt institutions are making greater use of alternative asset classes in pursuit of excess returns for their investment portfolios.

According to this year’s edition of the biannual Report on Alternative Investing by Tax-Exempt Organizations, published today by Frank Russell Company and Goldman Sachs, strategic allocations to private equity in Europe have increased at a faster rate than had been predicted in 1999.

The survey found that European assets committed to private equity doubled from E13.4bn in 1999 to E26.7bn this year. The average strategic allocation to the asset class rose from 2.5 per cent of fund assets in 1999 to 3.6 per cent. When polled in 1999, respondents had predicted average strategic allocation to rise to no more than 2.9 per cent.

Russell and Goldman canvassed 124 institutions in the UK and continental Europe, 93 of which responded. 51 respondents (55 per cent) said they invest in private equity, against 14 that have exposure to hedge funds.

Commenting on the reasons why Europeans had increased their exposure to private equity more aggressively than predicted, Nigel O’Sullivan, managing director of Goldman’s European Pension & Insurance Strategy Group, cited greater acceptance and understanding of the asset class as well as good returns as significant drivers.

Presenting the findings of the report alongside Hal Strong, managing director of Frank Russell Capital, at a press briefing in London, O’Sullivan also pointed to the Myners Review as a document that many institutions were examining to find guidelines on how to best incorporate alternative assets in their portfolios.

Respondents predicted a further increase in strategic allocations by another 0.7 per cent to 4.3 per cent in 2003.

This significant increase notwithstanding, European interest in private equity still pales in comparison with activity levels in the US. Total assets there rose from $152bn in 1999 to a whopping $220bn this year. US strategic allocations also grew, albeit at the modest rate of 0.2 per cent, from 7.3 per cent to 7.5 per cent.

Among the survey’s most significant findings is the fact that institutions on both sides of the Atlantic have committed to private equity well in excess of their policy allocation limits. In North America this is especially significant: Investors committed $60bn, or 34 per cent of the total, more than the policy allocation. In the UK, investors allocated E10.7bn and committed E12.4bn, whereas on the continent, organisations allocated E13.4bn and committed E16.3bn.

There are two reasons for over-allocation. One is that the decline in public market valuations has boosted the relative weight of private equity investment in portfolios. At the same time investors, recognising how difficult it can be to actually see money put to work in private equity funds as opposed to it being merely committed to them, over-allocate deliberately in order to stand a better chance of reaching their investment targets. (In contintental Europe for instance, no more than 52 per cent of committed capital is actually invested at this point.) O’Sullivan and Strong agreed that this second reason was the more significant cause of over-allocation at present.

Another important finding is that 90 per cent of Europeans respondents found that returns generated by investments in private equity had met if not exceeded their expectations going forward. This number is likely to attract a great deal of interest in 2003 when the next edition of the report will be published: It is uncertain at this point to what extent investors will emerge equally satisfied, given recent market developments.

Looking ahead, Europeans said that they remained bullish, expecting an average return of 20 per cent from private equity and venture capital investments by 2003. Their US counterparts, harder hit by recent market fluctuations, were more sceptical, saying they expected a return no greater than 15 per cent. Asked the same question two years ago about 2001, most US investors predicted a rate close to 20 per cent.