Pension investment in private equity

Pension investment key to the development of the asset class

Pension investment in private equity started in the United States and Canada in the late-1970s,^[1] 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.^[2]

Perceived benefits and substitution effect with listed equity

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 incentives for investments in SMEs and/or innovative technologies.^[3]

Research conducted by the London Business School Coller Institute of Private Equity (CIPE) suggests that for most pension investors “private equity and publicly-listed stocks are viewed as [...] substitute[s]... [there is] a strong negative relationship between quoted equity and private equity allocations”.^[4]

Long-dated liabilities allowing longer holding periods

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.^[5]

References