Head Abroad For Vacation From Denominator Effect

Fundraising is tough all over, but you may find it a mite easier if willing to travel abroad.

As a general rule of thumb, institutional investors outside the United States have newer private equity programs. That’s good news for fundraisers since it’s less likely that they’ve been hit with the dreaded denominator effect, in which depressed portfolio valuations push investors over their target allocations. Outside the United States you also run into investors less slavishly devoted to setting and maintaining target allocations to different asset classes; such organizations tend to have more flexibility to open their wallets for commitments when a good opportunity arises.

And finally, the large population of fund-of-funds managers based outside the United States, particularly in Switzerland, represents a significant pool of fresh capital. Many raised their latest funds during frothier times, and still have plenty of dry powder left to deploy. “Some of the funds of funds have multiple sources of capital, such as the balance sheet of a parent company or owner, and don’t need to rely purely on the success of their marketing,” said Jennifer Rinehart, a partner at international placement agency MVision Private Equity Advisers, which markets private equity funds to U.S., Asian, European, Middle Eastern and Australian investors.

Altogether, Buyouts Magazine has identified more than 30 potential limited partners that may well be in the market for U.S. private equity funds – see related table at right. Those that fall into one of the three categories described previously – newer investors, ones following a flexible portfolio approach, and managers of funds of funds – have almost $2 trillion of assets under management. Just bear in mind that you may well find many of them lukewarm to U.S. buyout opportunities. As in the United States, the flavors of the month tend to be secondary funds, turnaround funds and mezzanine funds.

Below-Target LPs

Although Europe and Asia boast their share of veteran private equity investors, you still find plenty of newcomers.

“European institutional investors are still allocating to alternatives, particularly in new areas like infrastructure, distressed and highly differentiated strategies,” according to a a recent study of fundraising produced by placement agency C.P. Eaton Partners. “The denominator effect is less of a factor for European alternatives investors, as the majority still are in the early phases of their allocation programs.”

One such example in Europe is the $20.4 billion National Pensions Reserve Fund of Ireland, established in 2001 to meet the costs of Ireland’s social welfare and public service pensions starting in 2025. Its private equity program was launched in 2005. Although the target allocation to the asset class is 8 percent, the actual allocation stands at only 3.2 percent, and the LP is expected to commit anywhere from zero to $50 million this year to U.S. managers, said Nick Ashmore, head of private equity. If the pension fund does decide to make new commitments this year in the United States, “it is likely to be late in the year and in a modest way,” said Ashmore. National Pensions Reserve Fund of Ireland has an appetite for both buyout and venture funds. Last year it backed funds managed by mega-firms Clayton, Dubilier & Rice and TPG; Montagu Newhall Associates, a venture capital fund-of-funds manager; and Oaktree Capital Management, which invests in distressed debt opportunities worldwide.

Many of the newest investors hail from Asia, where LPs have been looking to diversify beyond their home countries, particularly by backing distressed asset investors in both the United States and Europe.

Indeed, late last year the sovereign wealth fund of the government of China, the $200 billion China Investment Corp., established in 2007, hired Zhou Yuan, former head of Chinese investment banking for UBS, as its head of alternative investments.Already the LP has backed both private equity and hedge fund of funds, in addition to making direct investments in private equity shops. Along with a 12.5 percent stake in The Blackstone Group, China Investment Corp. last year supplied 80 percent of a $4 billion fund managed by financial services specialist J.C. Flowers & Co. Last month, the sovereign wealthy fund also pledged $800 million to a $6 billion global real estate fund managed by Morgan Stanley.

Elsewhere in Asia, the $110 billion Pension Fund Association of Japan hired consultant Hamilton Lane last year to help expand its private equity portfolio, although the size of the mandate has not been made public. Before that, the LP had committed to Japanese private equity firms, and also backed some mega-buyout funds through funds of funds. In January, meantime, the $10 billion Government Pension Fund of Thailand handed Switzerland-based Capital Dynamics a $330 million mandate to be invested over three years as part of its first overseas private equity program. U.S. buyout funds are being considered as part of the portfolio, according to a Capital Dynamics spokesperson.

Several Canadian investors are likely to commit to private equity this year. The British Columbia Investment Management Co., created in 1999, has a target allocation to private equity of 5 percent to 10 percent; as of March 31, 2008 its actual allocation stood at just 5.4 percent of its $70 billion portfolio. In the year ended March 31, 2008, the LP pledged $1.4 billion to 16 private equity funds and four co-investments, with about a third of that ending up in the United States. Among U.S. firms the Canadian investor has backed are funds-of-funds manager Adams Street Partners; mega-firm Apollo Management; tech-focused buyout firm Francisco Partners; distressed firms Oaktree Capital Management and Wayzata Investment Partners; and Tailwind Capital Partners, which closed its first fund in 2008.

The $36 billion Ontario Municipal Employees Retirement System invests directly in private companies, in addition to backing buyout, venture capital, mezzanine debt and turnaroundfunds. OMERS made minor investments in private equity in the past, but allocation to the asset class really began to grow in the late 1990s, said a spokesperson. And although it has now been involved with the asset class about a decade, OMERS remains below its target allocation to the asset class of 10 percent, with an actual allocation of 8.2 percent as of Dec. 31, 2008. Significant fund commitments made by OMERS in 2008 included ones to Onex Partners III LP, earmarked for large-scale acquisitions of North American businesses; TowerBrook Investors III LP, earmarked for investments in mid-sized and large companies based in Europe and North America; and mega-fund TPG Partners VI LP.

The $32.5 billion Alberta Investment Management Corp., established in 2008, has a target allocation to private equity of 5.3 percent, but its actual allocation stands at only 3.5 percent, giving it some room to grow. In fact, the LP expects to commit about $50 million to U.S.-based private equity managers in 2009, according to a spokesperson, down from $200 million last year. AIMCo’s reduced commitment pace stems mostly from a greater focus on doing direct private equity deals, said the spokesperson, but the large amount of its undrawn commitments is also playing a role. Pledges have gone to mega-firms The Blackstone Group, The Carlyle Group and Hellman & Friedman; and Matlin Patterson Asset Management, a firm that invests in distressed assets.

Flexibility Portfolios

Whether or not a foreign LP will pledge this year partly depends on how much flexibility it has in its private equity program.

The $90 billion Canada Pension Plan Investment Board, a major backer of private equity funds, does not set target allocations to individual assets classes, leaving it freer to invest opportunistically. Although CPP makes no predictions about the amount that might be committed to private equity in 2009, last year it pledged $3.9 billion to 11 U.S.-dollar denominated funds, including mid-market buyout fund Lindsay Goldberg III, earmarked for investments in North American manufacturing, financial services and health care companies.

Great Britain’s second-largest pension fund, the $36 billion Universities Superannuation Scheme, has a flexible private equity platform that gives it leeway to be nimble and opportunistic. The LP has no specific private equity target allocation but has about £1 billion ($1.5 billion) now invested. It expects to commit about £750 million this year, with a focus on distressed debt and secondaries. The pension fund has made no U.S. private equity pledges so far in 2009, but it is likely that more will go to distressed debt than to buyouts, said Michael Powell, head of alternatives. The projected commitment pace excludes investments made by Constitution Capital Partners, the strategic partner mandated to invest in U.S. mid-market funds on the pension fund’s behalf.

Funds Of Funds

Among the still-active funds-of-funds managers is London-based Hermes Private Equity, with $2.4 billion in assets under management. The largest pension fund in the United Kingdom, the $60 billion BT Pension Scheme, owns Hermes and is its only client, with a private equity target allocation of 4 percent, according to press reports. Look for Hermes Private Equity to commit between between £50 million and £150 million to U.S.-based managers in 2009, said Hermes director Susan Flynn. The firm’s current captive fund of funds, HPE 2008, is a £350 million vehicle that has already made five pledges totaling $186 million, 75 percent of which went to North American GPs.

Swiss funds-of fund-manager LGT Capital Partners, with more than $17 billion of hedge fund and private equity assets under management, manages the assets of more than 200 institutional investors from North America, Europe and the Asia Pacific region, but also oversees the alternative investments of the LGT Group, the family office of the Princely House of Liechtenstein, although that represents a much smaller part of the business. The LP does not disclose planned allocations to private equity segments, like U.S. private equity, but the firm commits more than $1 billion per year to managers globally, said Tycho Sneyers, partner. LGT Capital Partners has made pledges to mid-market buyout shops Arsenal Capital Partners, Heritage Partners, Odyssey Investment Partners and Wynnchurch Capital Partners; mega-firm Bain Capital; and distressed firm Oaktree Capital Management.

Dutch funds-of-funds manager Alpinvest Partners, Europe’s largest investor in private equity funds, with $53 billion in assets under management, commits exclusively to private equity on behalf of two Dutch pension funds, ABP and PFZW. AlpInvest Partners became the exclusive private equity manager for these funds in 1999 and has full discretionary power regarding investment decisions. The firm also manages commitments from Canadian and European pension funds. Alpinvest has committed $4 billion to $6.5 billion annually over the past few years, but expects to be on the low end of that range in 2009, said partner Helen Lais. “We do not plan too tightly on an annual basis, to allow for accommodation of the fundraising cycle,” said Lais. It pledges on average almost half of its annual allocation to U.S.-based managers. In 2009, the LP expects to be active in U.S. distressed, secondaries and mezzanine strategies via funds, co-investments and secondary opportunities. Pledges have gone to emerging manager Huntsman Gay Capital Partners, which invests in middle-market LBOs, growth equity deals and mid-cap public companies, and to Investcorp Technology Partners, which acquires small and mid-sized technology companies.