Funds-of-Funds Top Pick for Pensions in Private Equity

Funds-of-funds are North American pension funds’ favorite vehicle for private equity investments, according to Preqin data.

Both public and corporate pensions preferred the strategy, chosen by 71% of each fund type.

Funds-of-funds had among the lowest median internal rate of return of private equity fund types for every vintage year from 2000 to 2013, according to Preqin data released in March. However, they were also the least volatile across the same vintage years due to their inherent diversification.

On average, public funds targeted an 8.3% allocation to private equity, while private funds aimed for 7.3%. Both were underinvested as of May 2016, with public pensions investing 7% of total assets in private equity and private pensions allocating 6%.

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These North American pensions also favored buyout funds, preferred by 63% of public and private pensions, and venture capital funds, picked by 60% of public pensions and 58% of corporate pensions.

Internal rates of return have dropped for buyout funds founded in more recent years, according to Preqin, while venture capital funds have enjoyed a steady rise across vintage years.

Roughly half of public pensions also liked secondaries and growth funds. Private pensions, however, were less enthusiastic, with about a third expressing favor for each.

Co-investments, balanced funds, and turnaround strategies were the least chosen strategies for private equity investment, though each was slightly more preferred by public funds.

Both public and corporate pensions overwhelmingly preferred to invest within the domestic private equity market, though European-focused vehicles were also popular.

preqin private equity fund of funds Source: Preqin’s “North America-Based Pension Funds in Private Equity”

Climate change could expose investors to a host of systemic financial risks if unaddressed, according to Wilshire Associates.

The consulting firm, along with CIO columnist Angelo Calvello, argued that climate change and associated regulatory policies could directly affect asset class prices. Understanding and preparing against future climate change risks will take “wise, informed, and timely advice” as well as traditional risk management, they wrote.

Take rising sea levels, for example. Wilshire argued that an increase in sea level has “significant and direct economic implications” for many coastal regions, and furthermore can incur “large-scale losses” in real estate and infrastructure.

“Climate change and associated policy and regulatory changes have the potential to affect all asset classes, putting at risk exposures in equities, fixed income, real estate, infrastructure, real assets, commodities, and currencies,” the paper stated. “Such risks may not be entirely avoidable.”

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The change to low- and no-carbon emission energy sources will continue to curb oil prices, Wilshire continued. Add in geopolitical risks in countries like Saudi Arabia and one can expect nearly $2 trillion of capital expenditure at risk, according to the report.

There are also secondary systemic risks brought on by climate change.

Oil, gas, and utilities companies are significantly financed through debt, making up nearly one-third of the $2.6 trillion global leveraged loan market, Wilshire said. A substantial change in these asset prices could prompt “debt repricing and credit losses… [affecting] financial lending institutions, leading to possible ‘knock-on’ effects through the financial system,” the paper continued.

“Investors need to make decisions about a changing world where complete knowledge is impossible,” Wilshire wrote. “This is indeed the essence of risk management, since all risk is embedded with probabilistic considerations.”

Most likely investors will soon face “a new normal,” the consulting firm said, as some of climate change’s long-term consequences “cannot be undone.”

This new investing world would require much more than simple risk management, Wilshire warned.

“ESG issues are not merely collateral considerations or tiebreakers, but rather are proper components of the fiduciary’s primary analysis of the economic merits of competing investment choices,” the paper concluded.