Is there a specific allocation target you aim for when investing in private equity funds?
We have a target set for our investments in the overall category of alternatives, which is 20 percent. Under this category we have private equity, but also alternative credit, infrastructure, real estate, farming, and timberland. Some of these alternative strategies are by nature more liquid than others: private equity and infrastructure, for example, are among the most illiquid; real estate and alternative credit can be more liquid.
So when you look at how we actually invest, part of it is actually making sure we are not overweight on illiquid investments. But we’re also cognisant of the speed of growth of our total size of invested assets: three years ago we were closer to £4.4 billion (€4.7 billion, $6 billion); today we manage roughly £13 billion. So it’s very difficult to judge our size of growth of total assets versus our deployment speed to private equity. The same applies to the other illiquid alternatives we’ve got: they deploy over a period of time, which may or may not fit into the timeline in which we’re growing our total assets.
So we don’t particularly like to quote a specific target for each of these strategies, and that’s mainly because our growth has been so quick. What we actually do is to use the more liquid alternative assets, such as GTAAs and the more liquid alternative credit, to help balance that out to achieve our 20 percent overall for alternatives.
How does that compare to other big pension funds, which may have a different mandate than yours?
If you look at how much we’ve currently got invested in private equity, compared to the general industry, my guess is that we’ll end up in the middle of the range most of the time. We’re not much bigger, but neither are we doing it just for fun – it is a few percent but it is designed to be one of our key return drivers.
But we also consider our total equity exposure on a factor basis, that is our exposure to both listed equity and private equity. We look at the total risk of those in combination. And in this respect we tend to be different from the typical pension fund: we have only 10 percent exposure to listed equity, which is lot less than the industry average. In addition, much of our private equity investment is targeted towards secondaries funds.
How do you explain that? Why have secondaries proven so attractive?
At the general level, first, they tend to provide investors like us with a number of advantages: fast and significant diversification; a vintage fund investment strategy; some return differentiation, because of the discounts to NAV; faster realisation of capital; and faster investment of capital. This last point has been particularly important for us: over the last couple of years we’ve been trying to build up our private equity programme, and investing in secondaries has allowed us to deploy capital faster than if we’d invested in a primary fund of funds programme, or if we’d tried to develop primary capabilities internally.
Private Equity is a few percent for us but it is designed to be one of our key return drivers
Investing in secondaries is also very consistent with our funding targets for 2030. Our objective is to be fully funded in 20 years’ time, to be able to pay compensation to the members of eligible defined benefit pension schemes; but if we were to try and build up a primary programme to help us achieve this goal, there would be inherent difficulties in terms of the speed of building that programme up versus the speed of unwinding it. Secondaries, with the extra liquidity they provide, allow us to sidestep some of these difficulties.
As the ultimate guarantor of workers’ pension schemes, part of your role, as an investor, is to provide an extra layer of security to pension funds’ contributors. Yet you also seek enhanced performance through significant exposure to alternative assets. How do you combine this search for returns with the need to mitigate risks?
We’ve got 20 per cent invested in alternatives. Some large pension funds will be somewhere in the teens; others may be just above us. So we’re more or less in the average.
But where our strategy differs is that a large portion of our assets, maybe around 70 percent, is in government bonds or investment-grade credit type of assets. So we put a lot of our investments in what we perceive as very stable or relatively low-risk assets. And it’s not just UK government bonds – although they certainly form a reasonable part of it – we invest globally in the government bond and credit space.
The other point is that, within the types of investment strategies in which we are employing alternatives, some of the assets we deploy are designed to be uncorrelated return generators over the long-term. This includes GTAAs and alternative credit. So whilst it remains true that investing in private equity is a riskier strategy, we can balance this out by using other instruments. Managing the overall risk profile of our portfolio, in the end, is all about the blend.
Alan Goodman is principal in fund management at the PPF.