From your perspective, what are the main outcomes of this debate dedicated to the impact of Pension Funds?
African pension funds are in a strong starting position to create substantial value for their members going forward. With their high numbers of young contributors and fewer retirees, they can confidently take a longe-term investment outlook, and start now building portfolios that can generate a higher yield, by utilising more illiquid investment strategies in their portfolio. The debate has shown that there is a whole range of alternative strategies becoming more prominent in pension funds’ asset allocations – and this is for a reason. Alternative investments add a higher level of diversification, thus mitigating risk, produce higher returns with less volatility and often show lower correlation to traditional asset classes.
Still, pension fund trustees are hesitant for a number of reasons: bad experience from past investments, fear of being stuck in an investment for a long period of time as close-end fund typically runs for 10+ years, higher associated fees etc. All participants in the debate agreed that there is a clear need for more educational work to be carried out. To give knowledge and comfort to pension fund decision-makers, and to combat certain long-standing prejudices surrounding the alternative investment asset classes.
What strategies should be considered by shareholders looking for alternative opportunities to invest?
Private equity is a well-diversified asset class within itself. On the equity side, strategies range from early-stage venture capital to growth, to small and mid-market buyouts and leveraged buyouts. In addition, you have private debt strategies, mezzanine, distressed debt and secondaries. Plus, there is the whole range of real assets strategies. In order to identify the most suitable alternative investment strategy for their own portfolios, the pension fund should discuss with their consultants the objectives they want to achieve in relation to: target return (IRR / Money multiple), income generation, tolerance to risk, level of diversification needed, domestic versus offshore allocations, fees etc. This should ideally all go into a portfolio modeling process in order to find the right portfolio mix for the pension fund. Such a portfolio modeling can also take all other assets in a pension fund’s portfolio into consideration and by running stress tests facilitate a “value-at-risk” analysis.
What benefits can Alternative Investments offer to companies and individuals?
Reasons for allocating into private equity are numerous and include some of the following; the asset classes’ superior returns versus other asset classes. A 2019 study by Brown & Kaplan has shown that global Private Equity has outperformed listed equity every year since at least 1988 by at least one percentage point but in some years as high as 26 percentage points.
Another reason why Pension Funds like private equity comes back to its low correlation with other asset classes, as well as an increased diversification in the portfolio leading to stronger downside protection.
In an interview conducted by Invest Europe, The European Venture Capital and Private Equity Association pension fund representatives also cited private equity‘s long-term investment horizon as an advantage making it easier for them to navigate their cash in- and outflows more efficiently.
What solutions should be implemented to facilitate direct investment and co-investments?
Pension Funds doing direct investments and co-investments need to be aware of the increased workload associated with this and the higher concentration of risk. Private companies taking on outside investors’ capital and selling shares are doing this for a reason. Not only do they need additional capital for the growth of their company or for de-risking their own investments (the common term is “taking money off the table”) but they are also looking for a value add. This means they are seeking support, strategic advice, contacts etc. Therefore, a special skill set and experience in providing such advice are required. Additionally, pension funds need to be aware that often more time is required to manage direct investments. Pension funds preferring to go directly into companies could do so by doing co-investments alongside experienced private equity managers who can manage the investments for them. The prerequisite for getting access to this kind of co-investments is, however, a commitment in the private equity manager’s fund as managers are taking the lion share of these deals for the fund with the balance being offered to their existing investors for direct co-investments, oftentimes on a “no fee, no carry” basis. Another option could be a co-investment fund. Many funds of funds have established these kind of vehicles. These come with lower management fees and carried interest – typically 1 & 10 – and give more diversification (and hence are mitigating risk) than single transactions.