Friday Letter: Breakfast reading

How many institutional investors in need of yield coughed into their cornflakes recently when they read what was currently being generated in private equity and other non-mainstream asset classes?  

For those stood outside looking in, the success currently being garnered by the world’s leading private equity investors must do little to brighten their mornings. Take the big American public pension fund LPs: news this week that the $36 billion state pension fund of Massachusetts (MassPRIM) saw a formidable 13.4 percent overall return for the fiscal year ending 30 June was only the latest reminder that in the current environment, it pays to go the extra mile in pursuit of performance. Alternative assets including private equity and venture capital returned more than 25 percent for the Boston-based pension; real estate investment contributed an even more notable 30.8 percent gain. (And for those wanting to supersize their risk/return ratio, try emerging markets equities, which at 37 percent were MassPRIM’s best performer.)

The results from Massachusetts dovetailed nicely with the performance figures posted late last month by CalPERS, the largest public pension in the US with $190 billion in assets. CalPERS’s private equity portfolio delivered a 23 percent return during the 12 months ending 30 June, way above the target 14.2 percent that the LP had itself set as a returns benchmark for the asset class. And in real estate, the Californian leviathan achieved a whopping 38 percent.

Will these stellar returns last? As far as private equity goes, limited partner boats are currently being floated by arguably the most rapidly rising tide that the asset class has seen. Large buyout funds alone are returning so much cash to their investors at the moment that some LPs are quietly wondering whether the old industry mantra of investing with only a handful of carefully chosen managers in each strategy might in fact be a fallacy: “Given the distributions coming back out of this market, what we should have done a couple of years ago is buy every credible LBO fund we could have got our hands on,” quipped a Nordic private equity investor during a recent conversation with PEO.

Hindsight is of course both a wonderful and frustrating thing, and no one would be well advised to treat private equity’s current performance fest as a guarantor of return expectations going forward. Still, there is no doubt that investors in the asset class are currently reaping more than satisfactory rewards for the risk they have taken on in entering it.

Those institutions that are missing out on the boom ought to seriously ask themselves whether they can afford to remain on the sidelines for very much longer. Take German pension funds and insurance companies for example. Institutional fragmentation, fiscal obstacles and regulatory hindrances are the main reasons why German limited partners with meaningful exposure to international private equity are still so few and far between. As a result, German pensioners and policyholders are failing to benefit from private equity’s performance achieved not only abroad, but in their home market as well.

Now that some of Germany’s structural barriers to entry into the asset class have been removed entirely – in June of this year, new rules relating to the new Investment Tax Act (Investmentsteuergesetz) were brought in to help clarify the treatment of investment in foreign limited partnerships – and as a result German institutions should become more comfortable with the asset class.

Those determined to grab a piece of the action should proceed with caution though: market fundamentals will not remain as benign as they are forever, and to initiate a major fund investment programme from a standing start at this particular point in the cycle is to run the risk of getting the timing fundamentally wrong.

Still, nothing ventured really is nothing gained in today’s low interest rate environment. America’s pension managers – alongside many other adventurous institutional investors elsewhere – have demonstrated time and again that for yield-driven institutions, ignoring private equity is a bad idea. And how many times do you want to read about others’ good fortune over breakfast?