Preqin: North American Pensions Essential to Private Equity Capital

(January 22, 2013) — North American public pension funds continue to offer valuable capital to the private equity industry, Preqin says.

Preqin’s Investor Intelligence database that tracks 1723 investors actively looking to make new fund commitments shows 149 are North American public pension funds. Of these pension funds, 70% anticipate making new commitments to the asset class over the coming year.

Public pension funds in North America aiming to make new commitments in 2013, according to Preqin, include the $6.4 billion San Bernardino County Employees’ Retirement Association, which has planned commitments of $125 million over the next 12 months. The Seattle City Employees’ Retirement System expects to commit between $25 million and $30 million to private equity in 2013.

South Carolina Retirement Systems (SCRS) is also continuing to deploy capital to the asset class in 2013, the data firm noted. “In order to diversify its private equity portfolio by geography and strategy, SCRS will make commitments to third-party funds, including mezzanine, buyout, venture and distressed private equity vehicles, as well as investing in direct funds with specific strategies,” Preqin said in a release.

Never miss a story — sign up for CIO newsletters to stay up-to-date on the latest institutional investment industry news. 

The majority of North American public pension funds are looking to invest in North America-focused funds (56.7%), followed by funds including Europe (41.3%) emerging markets (37.5%) and Rest of World (14.4%).

Buyout vehicles remain the preferred fund type for North American public pension funds, with 52.9% expecting to commit capital to such vehicles over the next 12 months. Thirty-nine percent will consider distressed private equity, while 42.3% and 31.7% will consider investing in venture capital and growth funds respectively. Timber and natural resources vehicles are the fund type preference for 21.2% of North American public pension funds.

Yet that obvious propensity among public pensions to invest in domestic private equity firms may be hazardous, according to recent academic research. Two researchers at the Kellogg School of Management, Yael Hochberg and Joshua Rauh, recently published an article titled “Local Overweighting and Underperformance: Evidence from Limited Partner Private Equity Investments,” in the Review of Financial Studies. “Our analysis suggests that institutional investors of all types (endowments, foundations, public and corporate pension funds) exhibit substantial home-state bias in their PE portfolios,” the authors wrote. They found that institutional PE portfolios held an extra 8.1% of in-state investments on average, beyond what would be predicted statistically. For public pension funds, however, this over-allocation to in-state investment funds is even larger, at 9.7%.

Related video:“Mercer Warns of Home-Country Bias”

(January 22, 2013) — A greater willingness of managers of hedge funds, direct private equity, and infrastructure funds to negotiate fees has made alternatives the only asset class to have experienced a material drop in asset management fees, according to Mercer.

In alternatives, what was once a “2 and 20” industry standard continues to move toward “1.5 and 20,” a trend fueled by supply and demand dynamics leading managers to be more flexible in negotiating fees, Mercer said.

Geographically, the firm discovered that–taking all asset classes into consideration in US dollar terms–Canada remains the most inexpensive country/region in which to invest, with average median fees of around 0.3%. The UK and Europe are also relatively low priced, with average median fees of around 0.4% and 0.5% respectively. Emerging markets remain the most expensive country/region at 0.89% on average, with Asia averaging 0.75%, a decrease of 0.08% since 2010.

“Given the plentiful supply of good quality active management, the level and structure of active fees has been remarkably resilient to a slowdown in demand,” said Divyesh Hindocha, global director of consulting for Mercer’s Investments business. “As we move from a defined benefit based pensions system to a defined contribution based pension system, which is much more cost conscious, our hope and expectation is that we see some innovation in this area, as otherwise the demand for active management may well fall off a cliff.”

For more stories like this, sign up for the CIO Alert newsletter. 

The firm found that around a third of managers have increased their fees. Most small cap equity strategies have increased fees except in the US where such fees have tended to decrease.

Mercer’s 2012 Global Asset Manager Fee Survey, the fifth such biennial survey, analyzes data on more than 25,000 asset management products from over 5,000 investment management firms. The survey covers asset managers in a range of geographies and across numerous products, by way of pooled and separately managed accounts. The study is intended for use as a reference when assessing asset management fees.

The general topic of fees is often a sensitive one in the asset manager/owner relationship–both parties have competing goals when it comes to negotiating such a payment. In September, aiCIO examined the fee structure of the roughly $6.5 billion Wyoming Retirement System. The scheme has reworked the way it calculates fees for their managers in an effort to lower costs, compensate managers more fairly (in their view), and improve the incentive structure that guides manager decisions.

According to fund Chief Investment Officer John Johnson and Senior Investment Officer Jeffrey Straayer, fee structures for fund managers need to shift control into the hands of asset owners. Traditionally, fund-manager fee structures paid by pension funds have led to overpaying managers when they’re doing well, yet managers maintain that payment when they’re underperforming, according to Johnson. Most asset owners have fund-manager fee structures that include high fixed fees with a performance fee added, which leads to fund managers indexing and gathering assets to maximize their paycheck, Johnson told aiCIO in September. “That business model shifts risk to the pension fund rather than to the fund managers.”

Related article: Are You Mispaying Your Manager?