Target allocation to PE:
4% net invested
HarbourVest Partners, Adams Street Partners, Hamilton Lane
Pension fund performance:
14.1% year-to-31 August; 230.8% since inception
Private equity performance:
The programme has delivered MSCI ACWI + 3% IRR net** since inception
Source: AP7 *as of August 2018; **as of 31 March 2018
For an asset class that contributes so much to the Swedish economy, private equity still faces perception challenges. Local market participants have described private equity as something seen in conflict with Swedish culture and values. Yet the figures are compelling: the cumulative effect of private equity investments in Swedish firms has been to raise the country’s GDP level by as much as 6 percent since 2005, according to data from consultancy firm Copenhagen Economics and the Swedish Private Equity & Venture Capital Association.
Swedish institutional investment in private equity is much lower compared with counterparts in Denmark and Finland where the asset class is more widely accepted. A longstanding dispute over whether to tax carried interest as income or capital gains, coupled with the threat of backdating the laws to cover carry already earned by buyout executives has loomed like a cloud over the private equity industry for the last decade. In June, the Swedish Supreme Administrative Court finally ruled in favour of the Swedish Tax Agency and determined that a significant portion of carried interest paid to general partners should be taxed as income, not capital.
To some, the decision provided much needed clarity for the private equity industry. To others, the process, estimated to have cost Swedish taxpayers around SKr100 million ($11.1 million; €9.5 million), resulted in a complete loss of confidence in the country’s tax and court system and is prompting Sweden-based PE funds to consider leaving the country, according to market sources.
It’s against this backdrop that Per Olofsson, head of alternatives at AP7, is attempting to build the Swedish pension fund’s private equity programme. When Private Equity International sits down with him in late August in the pension’s Stockholm office, Olofsson has just returned from a trip to the US where he met with private equity managers up and down the country. The meetings were an opportunity to develop closer relationships with direct investment GPs so AP7 can have greater control of how it builds out its private equity programme – something Olofsson describes as hard work but “a lot of fun”.
With around 4.5 million members, AP7 is the default provider in Sweden’s premium pension system and its only defined contribution fund. Yet it employs only one full-time member of staff focusing on private equity: Olofsson. His biggest challenge? Ensuring AP7 achieves its private equity target allocation of 4 percent invested as the pension’s assets under management grow rapidly.
“When I started working here almost 15 years ago we had about $2.5 billion in assets. Today we’re at $55 billion,” Olofsson says. Around $20 billion of that is inflows to the fund – a double-edged sword that yields growth and poses challenges. “It means we have to constantly write bigger tickets to achieve our target.”
I hear from managers that everyone has a good set-up and strategy for not being too affected by a potential downturn. That can’t be true
Olofsson declines to comment on the average ticket size but points to the SKr10 billion it has awarded over the last year for separately managed accounts. HarbourVest Partners and Adams Street Partners picked up SKr4.2 billion and SKr2.3 billion respectively, while the pension has also entrusted $312 million to Hamilton Lane. The mandates are typically spread over 10 underlying GP relationships and comprise primaries, secondaries and co-investments, with the latter two accounting for around 20 percent in total.
Despite these recent investments, AP7 is hungry for more GP relationships. The pension is still below its 4 percent net invested target, though not overcommitting is a balancing act.
“The most important thing is to keep the discipline, and even though we’re behind our target at the moment, we’re not going to overcommit just to quickly reach that target,” Olofsson says.
AP7 has been investing in private equity since 2002 and has a very long investment horizon. “We’ll gradually get there. Quite frankly the equity markets can’t go like this for ever. The denominator effect will also help to play at one point.”
One way AP7 has been building its portfolio is through acquisitions on the secondaries market.
“I do think it’s a very good thing that the secondary market has evolved in such a way,” Olofsson says, referring to the increase in annual deal volume. Around $58 billion worth of secondaries traded last year, a 132 percent rise compared with five years ago, according to advisor Greenhill Cogent. “If for some reason you want to re-allocate within your portfolio it’s much easier to do.”
AP7 has sold small limited partnership positions but has been more active on the buyside, Olofsson says. One programme the pension acquired in late 2014 at around a 24 percent discount to net asset value has almost doubled in value.
“You really have to find the inflection point,” he says. “I would rather buy a programme that is just about to become cashflow positive within the next 12 to 24 months because that’s where you can pick up good value.
“While building an in-house secondaries team isn’t a priority, the pension remains willing to make opportunistic purchases of LP stakes, Olofsson says.
If there’s one thing that keeps Olofsson awake at night, it’s how a downturn in public markets could affect AP7’s and other pensions’ portfolios. This will be most acutely felt with co-investments, which many Swedish and European pensions have embarked on en masse.
“My impression is that you can go ahead and allocate to these asset classes but you’re not allowed to spend too much money on fees,” Olofsson says. “It’s an impossible equation unless you’re going to do it in-house, and this is forcing a lot of funds to do a lot of co-investments.”
AP7 only makes co-investments through dedicated discretionary co-investment funds that charge fees “much lower than one-and-10” and account for 10 percent of the pension’s portfolio, Olofsson says.
“I don’t think we’ve been through a whole cycle yet with co-investments and there are certainly some challenges there,” he says. The pressure and tight deadlines in which to decide on co-investments can make decisions almost impossible, he adds.
“The GP may have been working on the deal for six to 12 months, and you have three weeks to decide if you want to participate or not. It’s very hard to make up your mind unless you have a very strict process and internal resources. You may not even have time to meet with the company, if possible. How can you form your own opinion?”
We have to constantly write bigger tickets to achieve our target
EMEA-based GPs deployed €19.2 billion through 857 entry transactions in the first quarter of this year, down from €37 billion across 913 deals from the same period last year, according to research from S&P Global Market Intelligence. Near-record levels of fundraising by private equity vehicles last year have added to the surplus of dry powder – estimated at more than $1 trillion, according to Bain & Company – amid high valuations.
LP capital is therefore increasingly being held in limbo, with an average 1.2 percent of committed capital to a given fund called in the fourth quarter of last year – a record low – according to data from private equity software provider eFront.
Olofsson says this is where a bit of volatility in public markets would be a good thing. “Managers are holding back on buying companies. Valuations are really stretched at the moment.” He has doubts, of course, that every GP can emerge from a downturn unscathed.
“I hear from managers that everyone has a good set-up and strategy for not being too affected by a potential downturn. That can’t be true.”
All in the same boat
The Nordic region is usually heralded for its leadership when it comes to environmental, social and governance issues. For AP7, private equity was the first asset class it decided to focus on for ESG issues. The pension speaks to its GPs every year and rates them on a scale of one to 10, with clear targets on how they can achieve a higher rating.
AP7 employs a full-time ESG analyst internally and relies on other staff as well as help from external consultants. The pension has pushed – successfully – for ESG to become a standing item on the agenda at all its GPs’ advisory board meetings, something Olofsson says the pension is “quite proud” of. On gender diversity and ethnic equality, things are “not where we would like them to be but we see a gradual improvement”, he admits.
“We strongly believe that we’re all in the same boat,” he adds. “In the end it’s really to make things better.”