US private equity allocations to rise 58%

Roughly two-thirds of institutional investors are expected to increase or maintain their allocations to private equity, resulting in a 6.8 percent average allocation among US investors by 2012. The number is far greater than expected allocations in Japan, which are estimated to average 2.5 percent by 2012, and Europe, where average allocations are expected to be 3.7 percent, according to a recent survey of institutional investors by Russell Investments.

For the US, it would mark a return to previous levels. Prior surveys had shown that from 2001 through to 2007, US investors had consistently dedicated 6 percent to 8 percent of their total portfolio share to private equity. However, last year saw a reduction in that share to 4.3 percent due to a strong stock market rebound which increased the share occupied by publicly traded equities.

According to the survey however, by 2012 the total portfolio allocation for all alternative investments will rise to 19 percent from 14 percent in 2009, with most of the re-allocated funds expected to be drawn from public equities. Respondents commented that this is primarily a move to decrease portfolio volatility.

In order to mitigate this volatility over the next few years, investors will be increasingly turning to alternative investments, and in particular to private equity, whose long holding periods are seen as an antidote to stock market risk over time. The total expected average for private equity allocation across all regions in 2012 is 4.9 percent; a 58 percent increase from 2009 levels.

For other alternative asset classes, the survey found that the portfolio share for hedge funds is expected to rise from 4.2 percent in 2009 to 5.7 percent in 2012. The portfolio allocation for real estate amongst all respondents averaged 4.1 percent; 4 percent for the US, 4.9 in Europe and 2.7 in Japan. However, by 2012 investors are expecting valuation-driven increases in all these regions, with the average allocation share expected to increase to 6.6 percent by 2012. Infrastructure investment allocations averaged 0.3 percent across all regions in 2009 and this figure is expected to rise to 1.4 percent in 2012.

For the one-third of the survey’s 119 global respondents who planned to reduce their allocations to alternative investments, 46 percent cited liquidity concerns as a factor in their decision. Liquidity issues also played a role for investors choosing which alternative investments to commit to; 44 percent of respondents said that they “already have or soon will” differentiate their alternative investment choices by liquidity risk.

Management fees were also flagged as an issue, with 34 percent of those reducing their investments in alternative assets citing this reason. Many respondents reported that size and relationship were major barriers to increasing their bargaining clout for lower management fees – “though many had tried”. Russell said however, that the ability to influence terms is becoming more balanced between managers and investors.

Russell said that within the alternative investment world in general a process of “recovery and evaluation” was now well and truly underway. Changes which may characterise this period appear to be greater consciousness regarding transparency and governance issues. In particular, the Madoff saga, has acted as a “cautionary tale” affecting all levels of the institutional investment process and “has increased the focus on transparency, frequent manager reviews and operational due diligence”. One respondent commented that institutional investors could no longer invest in “black boxes”. 

Regarding governance, 84 percent of firms surveyed planned to make changes in their governance and risk management approach or have already done so, with 44 percent increasing the depth and frequency of reporting and 39 percent indicating that they are providing boards and senior management with more active education and briefings.