Portfolio managers with some of Canada’s largest pension plans are hoping that high returns from increased direct private equity investments in emerging markets and emerging sectors, such as mobile technology, will balance out the low returns that have plagued public markets since 2008.
“Since the downturn, we have been spending more time investing in emerging markets,” said Tanya Carmichael, portfolio manager with the Toronto-based Ontario Teachers’ Pension Plan, who spoke on a panel of pension fund managers at the 2012 Private Equity Symposium in Toronto, hosted by Canada’s Venture Capital and Private Equity Association, on Tuesday.
Prior to the recession, the private equity team at the OTPP sought growth from emerging markets by way of funds offered by private equity firms, which actively invested in emerging-market operations on their behalf.
Today, about half the funds dedicated to emerging markets go toward direct investments in emerging-market firms, which the group handpicks in tandem with its private equity partners.
Canada Pension Plan Investment Board’s private investment department is also looking to raise its investments in Asia. It will also be increasing its direct investments in mobile and social media start-ups, added Henry Zhang, a private investment associate with CPPIB who also spoke on the panel: “We believe this is a large growth area.”
Despite the current investment environment, the benchmark for making a direct investment in a start-up or private equity fund is an average annual return of 20% over a period of 10 years, added Zhang: “This is the rule of thumb in the industry.”
Although 20% may seem ambitious for a rate of return compared with public markets, it’s the bare minimum a pension fund must look for to compensate for the risk it is taking on, said panelist Ed Rieckelman, vice president of Alberta Investment Management Corp.’s private equity group.
“There’s a lot of risk in private equity, which most people don’t understand,” he said. “This should merit a return as high as 30% in some cases.”
Part of that risk comes from the illiquidity of being unable to cash in the shares of a private investment. As the shares of firm financed via venture capital are not publicly traded, investors cannot readily cash out their shares until buyer is found. For some businesses, there isn’t always a ready and willing buyer.
The same illiquidity risk is present in venture capital funds, for which the fund buys ownership in high- risk start-up or growth firms and offers its investors privately traded units in exchange. Investors, in turn, cannot cash out their shares until a private trade is made.
In today’s market, in which no sector has been totally immune to poor economic conditions, Carmichael said, it is becoming harder to find private equity that meets the benchmarks.
“It’s out there, but private equity investors have to spend more time researching venture capital firms that have general partners that can offer it,” she said. (General partners refer to the managers of a venture capital firm who decide which firms to buy stake in.)
The same is true for high net-worth clients looking to buy into venture-capital funds individually, Carmichael noted: “This is where they must ask more questions of their advisors, who are suggesting they make these investments.”
Currently, private equity makes up 16.3% of $152.8 billion of CPPIB’s assets under management. As for the OTTP, the private capital group makes up 10.4% of its $117.1 billion in AUM.