Pension investment in private equity refers to an important component of
pension fund
A pension fund, also known as a superannuation fund in some countries, is any program, fund, or scheme which provides pension, retirement income. The U.S. Government's Social Security Trust Fund, which oversees $2.57 trillion in assets, is the ...
investing known as the Endowment Model (also referred to as
The Yale Model, credited to
David Swensen and Dean Takahashi).
A pension fund may invest directly in private companies, or indirectly via
private equity fund
A private equity fund (abbreviated as PE fund) is a collective investment scheme used for making investments in various equity (and to a lesser extent debt) securities according to one of the investment strategies associated with private equity.
...
s. This is a departure of the classic "70-30 Model" where a pension fund would invest 30% of its assets in
publicly-listed stock. The perceived benefits of investing in private companies include the improved ability to diversify by region, industry, and sector, in addition to being able to invest in a greater selection of companies (including privately held companies, not listed on a stock exchange). A perceived drawback is the lack of liquidity of such private investments.
History
Pension investment in
private equity
Private equity (PE) is stock in a private company that does not offer stock to the general public; instead it is offered to specialized investment funds and limited partnerships that take an active role in the management and structuring of the co ...
started in the United States and Canada in the late-1970s, an era of high inflation and mediocre performance for most listed equity markets, when large institutional investors began to
diversify into “non-traditional”
asset classes such as private equity and
real estate.
The trend towards increased allocation to private equity including venture capital accelerated after 2009–2010. At the start of the
Great Recession
The Great Recession was a period of market decline in economies around the world that occurred from late 2007 to mid-2009. in the late 2000s, European and Canadian
financial economics
Financial economics is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on ''both sides'' of a trade".William F. Sharpe"Financial Economics", in
Its co ...
experts notably from the
World Pensions Council estimated that:
Perceived benefits
The traditional drivers of pension investment in private equity include statistical diversification stemming from partial decorrelation to listed securities (‘listed equity’ i.e. stocks and also bonds), expectation of superior risk-adjusted returns over long periods (typically 8 to 10 years), access to early-stage industries and
fiscal incentive
In general, incentives are anything that persuade a person or organization to alter their behavior to produce the desired outcome. The laws of economists and of behavior state that higher incentives amount to greater levels of effort and therefo ...
s for investments in
SMEs and/or innovative technologies.
Research conducted by the
London Business School
London Business School (LBS) is a business school and a constituent college of the federal University of London. LBS was founded in 1964 and awards post-graduate degrees (Master's degree, Master's degrees in management and finance, Master of B ...
Coller Institute of Private Equity (CIPE) suggests that for most pension investors “''private equity and publicly-listed stocks are viewed as''
..''substitute''
..
here is''a strong negative relationship between quoted equity and private equity allocations''”.
Large pension funds typically have long-dated liabilities (longer than those of other institutional investors such as banks or insurance companies). They have a generally lower likelihood of facing liquidity shocks in the medium term and thus can afford the long holding periods required by private equity investment.
[M. Nicolas J. Firzli ]
‘The New Drivers of Pension Investment in Private Equity’, Revue Analyse Financière, Q3 2014 – Issue N°52
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References
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Pensions
Sovereign wealth funds
Private equity
Equity securities