Friday Letter Private equity to the rescue

‘Traditional’ asset classes are expected to produce lackluster returns this year, highlighting once again the importance of private equity for investors to reach their overall returns objectives.    

Lower your expectations. That’s the message many financial analysts and market gurus are delivering to investors this year, predicting volatility – and perhaps global recession – on the back of issues including Europe’s debt crisis as well as high unemployment and reduced consumer spending in developed economies.

Bill Gross, head of the world’s largest bond fund manager PIMCO, said in a recent investor outlook letter that stocks, bonds and commodities were likely to produce returns in the range of just 2 to 5 percent this year – well off from the low double-digit returns most investors expect from their equities portfolios.

For many institutional investors, that means that alternative asset classes are likely to take on an even more important role in their portfolios. That’s not to say that allocations to private equity will suddenly be increased in a reactionary way – nor that private equity funds will be immune to the effects of any broader market uncertainty (just ask an LP about the write-downs that plagued portfolios in 2008-2009) – but long-term outperformance by private equity funds will be relied upon even more to drive their investment programmes’ overall returns.

“Short term developments are important – you have to pay attention to them – but you shouldn’t get too emotional about them,” Joe Dear, chief investment officer at the California Public Employees’ Retirement System, recently said during an interview that will be featured in Private Equity International’s February issue. “Our belief is the equity markets are highly efficient and for publicly traded securities we’re happy with a slightly better than market return. Where we want to earn the premium is with private equity. That’s a deeply held and long held belief,” he said, adding that private equity was “enormously important to the success of the programme in meeting its long-term target [return] objective of 7.75 percent”.

CalPERS is not alone in this thinking. A recent survey by Coller Capital found that 83 percent of the LPs queried planned to maintain or increase their target allocations to private equity over the next year (despite the fact that they had lowered their returns expectations for the asset class from their 2006-2007 peak). Again, that doesn’t mean commitments will be falling from the sky – but it serves as a reminder of private equity’s key role in portfolio management, particularly during difficult times.