Euro pension funds slowly warm to selling

Pension funds in Europe started investing in private equity later than their US counterparts and don't yet have a strong need for portfolio management.

While European limited partners such as family offices and financial institutions have been actively using secondaries market for portfolio management in recent years, European pension funds are less prominent.

In many countries, pension funds are in the process of building out portfolios, says Bernhard Engelien, managing director of Greenhill Cogent.

“Pension funds started investing in private equity much later than their US counterparts and so the need for portfolio management is not yet as strong,” he says. “Many also have lower allocations to private equity, with 2 percent to 5 percent being the norm, as opposed to 10 percent to 15 percent in the US.

“There is also a reluctance to sell at a time of low interest rates and high distributions as there are few other asset classes that can generate private equity level returns. That said, we have seen some activity over the last two to three years among UK, Scandinavian and Swiss pension funds, whose portfolios are a little more mature.”

Yet while European portfolios may not be as mature as those in the US, there is clearly scope for this type of transaction to grow, particularly if pricing remains attractive. It is currently at an all-time high of 92 percent of NAV on average, according to Greenhill Cogent.

“One of the main drivers for sales in the current market is good headline pricing,” said Mathieu Drean, managing partner at Triago. “The amount of capital raised by secondaries funds, coupled with interest from non-specialist buyers, such as investors looking to build out portfolios, clearly creates demand. This comes at a time when NAVs themselves are rising on the back of buoyant stock markets.

“Distributions are up and typically in such times, LPs don’t sell because they are generating liquidity. However, despite high distributions, we are still seeing a high volume of sales, so it’s clearly not about getting cash – they are taking advantage of a favourable environment to clean up and rebalance their portfolios.”

Broader acceptance

European investors are also now starting to get more comfortable with the secondaries market, particularly as pricing has improved for sellers. “Five years ago, the assumption among LPs was that the secondaries market was punitive,” says Drean. “Now, they see it as a viable option, not only to rationalise portfolios, but also to help them realise strategic goals.”

Skandia Life is among those LPs currently building up private equity portfolios. “While we started investing in private equity in 1989, it’s only since 2007 that we’ve ramped up the programme,” says Jonas Nyquist, head of buyouts at the Scandinavian insurer.

“We now have 10 percent of our capital invested in private equity and as we are still in build-up mode, we’re not looking at selling. We did sell a few interests a few years ago for regulatory reasons and we acquired fund interests in 2009, when pricing was much lower, but our involvement to date has been more opportunistic than strategic.”

That may change in times to come, however. “We are seeing through our secondary fund investments that many LPs are selling for strategic reasons,” adds Nyquist. “And I think that in, say, two years’ time when our portfolio is more mature, we may well look to sell in the secondaries market to help tidy up or rationalise our portfolio.”

Increased secondaries activity is, in turn, changing one of the long-held features of private equity fund investment – its illiquidity.

A report last year by SEI, found that nearly half of GPs and a third of LPs and consultants believed that private equity was becoming an “increasingly liquid asset class”, with the rise of secondaries a major contributor to this.

“The growth in the secondary market over the last five years has been substantial,” says Mark Calnan, global head of private equity at Towers Watson. “That is rapidly increasing liquidity in what has historically been a highly illiquid asset class — and that is a positive development for all investors in the market.”

This is a condensed version of an article that previously appeared in sister publication Private Equity International. Reporting by Vicky Meek.