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ITEM PF14
PENSION
FUND COMMITTEE – 25 NOVEMBER 2005
PRIVATE
EQUITY REVIEW
Report by
the Head of Finance & Procurement
Background
- Up to 1990 the
Pension Fund invested in private equity on a piecemeal basis through
private unquoted funds where the investment had to be held for seven
to ten years until all the underlying investments had been sold and
the proceeds returned to subscribing institutions. Without financial
advice the private funds selected for the Pension Fund produced a mixed
performance, with one out of the four funds more than doubling the amount
invested, another just producing a profit and the other two making substantial
losses during a period when quoted equity markets were very strong.
- In 1993 the then
Investment Sub-Committee agreed that no further money should be invested
in unquoted private equity funds, but in future investments in private
equity should be made through quoted private equity investment trusts.
A portfolio of such quoted private equity investment trusts was steadily
built up first to 2% of the total assets of the Pension Fund and eventually
to the current 4%.
- In August 2005
the Pension Fund Committee agreed, as part of a strategic asset allocation
review, to increase further the Fund’s private equity weighting from
4% to 6%.
- This report reviews
the current arrangements for managing private equity and recommends
how the additional 2% should be invested.
Details
of the Private Equity Segregated Portfolio
- Details of the
current private equity portfolio, including the geographical and financing
stage breakdowns, are shown in Annex 1 (download
as .xls file) and Annex 2 (download
as .xls file).
- All the investments
are quoted, with the exception of Questor and the Midlands Growth Fund,
which were taken out during the mid 1980s. The Independent Financial
Adviser is responsible for managing the portfolio and making the investment
decisions. The Investment Trust Team at UBS Investment Banking Division
produces research material with recommendations. The only fee they charge
is broking commission on all trades.
- Since the investment
trusts are quoted, the portfolio is actively managed; with trusts being
sold when it is judged the underlying investments have achieved their
potential and then the proceeds invested in more attractively valued
quoted investment trusts. The performance of the portfolio has been
good and added value to the Pension Fund as the following figures show.
As
at 31 March 2005
|
Performance
|
1
year
|
3
years
|
5
years
|
10
years
|
|
|
|
|
|
|
|
Private
Equity
|
27.7%
|
9.9%
|
3.9%
|
11.7%
|
|
|
|
|
|
|
|
Total
Pension Fund
|
13.5%
|
2.9%
|
-0.4%
|
7.5%
|
- Hymans Robertson
reviewed Oxfordshire’s private equity management arrangements in 2002,
as part of a more comprehensive management review. They reported "Oxfordshire
have a sizeable commitment to Private Equity, which they intend to increase.
However, in our view the strategy appears to be unbalanced in that there
is no exposure to the United States, the world’s most developed and
sophisticated private equity market. In addition we suspect that the
portfolio is over exposed to early and expansion stage investment. In
our view the Fund requires to appoint a professional "Gatekeeper" who
will develop the portfolio in such a way as to achieve a more balanced
diversification in terms of geography, investment stage and time. This
manager should develop a segregated portfolio that is complementary
to the existing exposure and the manager should manage the existing
exposure."
- Officers and the
Independent Financial Adviser did not agree with many of the above comments.
There was and is an overseas exposure, which is shown in Annex 1, though
arguably a more even split between the UK and overseas would improve
the diversification further. In our view the portfolio contains a reasonable
spread of the different financing stages (see Annex 2). As regards appointing
a "Gatekeeper", which is the term used for a manager of a private equity
segregated portfolio, this was viewed as an unnecessary extra tier of
management. The Committee fully concurred with the officers’ views and
no changes were made to the management arrangements.
Managing
the Segregated Portfolio Post Mr Bushell’s Retirement
- Paragraph 6 explained
that Mr Bushell is responsible for managing the private equity portfolio.
Mindful that he may be looking to retire from his post in the next few
years, officers met the UBS Investment Trust Team in London during September
2005 to discuss the possible management arrangements post his retirement.
- Officers met the
UBS Broking Division’s Executive Director of Investment Trusts and the
Private Equity Analyst. They explained that they maintained regular
contact with Mr Bushell, speaking to him once or twice a fortnight,
to keep him informed of market developments and their views. They said
that the market in private equity trusts is not large, with less than
20 quoted companies.
- They saw no reason
why the current management arrangements for the segregated portfolio
could not continue to operate smoothly and effectively were a new Independent
Financial Adviser to be appointed, provided s/he had been an experienced
investment manager.
- Officers receive
a monthly schedule of the private equity investment trusts from UBS.
This provides a variety of useful information such as the latest share
prices, Net Asset Values (NAV) and the discounts or premiums to the
NAVs. The analysis also contains the geographical breakdown and the
amount of cash being held for reinvestment for each trust. In addition
officers also receive from the UBS Private Equity Analyst his latest
market reports for each trust, so that they know his current views.
- Officers also
discussed with UBS the various options for investing the further 2%
earmarked for private equity. Officers expressed their concern that
the market for quoted private equity was not large and further investment
in these might mean building up sizeable holdings in some of the smaller
trusts. Furthermore achieving a higher overseas exposure in private
equity would not be so readily achievable by investing in UK based quoted
trusts
- UBS felt that
there were still good investment opportunities in some of the other
investment trusts that the Fund is not currently holding, which could
accommodate a further 2% in quoted investment trusts. They named 3i,
Dunedin Enterprise, F&C Private Equity and JZ Equity as all suitable
investments. Alternatively, investment in these trusts could allow a
further diversification within the existing 4% segregated portfolio.
The Independent
Adviser’s View on the Private Equity Arrangements
- Mr Bushell felt
that a new financial adviser could be perfectly capable of managing
the existing segregated private equity portfolio if he or she had relevant
experience in managing institutional investment portfolios. He explained
that in most instances he initiated the investments or disinvestments,
and on some occasions had not acted on the recommendations made by UBS
because he held a different view.
- Mr Bushell was
much less enthusiastic in committing the further 2%, earmarked for private
equity, to the quoted investment trust sector. He gave his reasons as
being the small size of the market and the fact that the choice of some
trusts was further limited by their underlying portfolios being at a
stage that made them unsuitable investments.
- His preferred
way forward was to invest the 2% in unquoted private funds, but on a
structured basis. This would essentially mean investing through a fund
of funds, where a specialist manager operated the fund, investing in
a carefully selected spread of unquoted private equity funds. This would
be a quite different arrangement compared to when the Fund last invested
in private funds in the 1980s. Then investment was not made in funds
of funds but in single funds only and officers or members and not a
specialist manager made the fund selection. Mr Bushell felt that the
fund of funds route offered many attractions including more overseas
exposure and a wider spread in the different financing stages.
- He also felt that
the private fund of funds route would provide an alternative arrangement
for managing private equity. Once a private manager had been appointed
then there was still the future option of partly switching out of the
existing segregated portfolio if so wished. Most local authorities that
have invested in private equity have tended to take the fund of funds
route.
- However, Mr Bushell
acknowledged that there were disadvantages with the fund of funds approach.
It would involve going out to tender and also add an extra layer of
management fees. Furthermore, unquoted private funds are not liquid
like the quoted investment trusts. He did not see this latter point
as being such an issue for the Oxfordshire Pension Fund, because it
is still cash positive and able to take a long-term view in its investment
strategy. On balance he believed the advantages outweighed the disadvantages.
Officer
Meeting with Bfinance
- Were the Committee
to agree to appoint a private fund of funds manager to manage the further
2% of funds, then this would necessitate going out to tender. With this
in mind Officers held a meeting with representatives from bfinance,
who are a company that specialise in handling the tendering processes
for more complex financial contracts.
- Officers, members
and the Independent Financial Adviser are already familiar with bfinance
because they were appointed to carry out the much more arduous and complex
management tender process for the Pension Fund’s four mainstream managers
in 2003. The officers were very impressed with the quality of their
process and reporting. Furthermore, the outcome has proved to be very
successful.
- Were bfinance
to be appointed then they would carry out the whole tender process,
including evaluating all the responses, on behalf of the Pension Fund.
This would be the most cost effective and efficient means for appointing
a private equity manager of managers. There would be no cost to the
authority in using the services of bfinance who earn their fee by charging
the successfully appointed manager a commission. It should be emphasised
that bfinance have absolutely no involvement in the selection process.
Their role would be solely to carry out the tender process and to summarise
all the responses into a report format.
- If bfinance are
used to carry out the tender process then it is recommended that Mr
Bushell and officers be delegated the responsibility for drawing up
a shortlist and then interviewing and appointing a suitable manager
or managers. The successfully appointed manager(s) would need to prove
that they have both the capabilities to invest overseas and to be able
to achieve a spread of investments across the whole private equity financing
spectrum i.e. from very early stage through to mega buy outs.
- It is not considered
necessary to appoint and pay for a consultant to assist with this exercise.
Not only would this be expensive but it is not considered that it would
provide any added value. Mr Bushell has a sound knowledge and understanding
of the private equity market and his expertise should be utilised.
- bfinance have
had experience in carrying out the private equity management tender
and search operations for a number of private and public sector pension
funds. They have carried out such exercises for the London Borough of
Hammersmith and Fulham, London Borough of Hillingdon, the Environment
Agency and Powys County Council. They are currently carrying out the
private equity tender arrangements for Dorset County Council.
Tender
Process and Timetable
- bfinance advised
that the tender and manager appointment process would take a minimum
of three months to completion, with the OJEC notice alone taking up
52 days of time.
- They also advised
on the desirability of tendering for a slightly higher figure than 2%,
which currently equates to £16 million. They explained that it normally
take at least four years to become fully invested in a fund of funds
because cash is drawn down as and when it is required for investment.
As a consequence if the Pension Fund’s value continues to rise over
the draw down period then £16 million may prove insufficient to attain
the desired 2% weighting. They further explained that with a fund of
funds, as individual companies get sold off, capital is returned to
investors with the consequence that is difficult to ever be fully invested
at any particular time. Taking into account these considerations they
have advised that tenders for an investment of £20 million should be
sought so as to avoid going through a further tender exercise.
- Expanding further
on the arguments set out in paragraph 28 there was some discussion as
to whether the tender should be for up to 6% of the total Oxfordshire
Fund. Thus, if over the longer term any of the 4% segregated private
equity portfolio is liquidated and the proceeds then switched into a
fund of funds, this would avoid the need to go out to tender. bfinance
said that this provision could be built into the tender contract so
long as the initial 2% investment sum was specified.
Conclusions
- The current arrangements
for managing approximately 4% of quoted private equity in a segregated
portfolio should be continued for the time being. It has been very successful
and produced very good investment performance. There is no reason why
this arrangement cannot continue to operate smoothly with a new Independent
Financial Adviser after Mr Bushell has retired.
- However, the further
2% earmarked for private equity should be invested in a private global
fund of funds. This would provide the best means for increasing the
private equity’s overseas exposure and achieving further diversification
at the financing stage.
- The tender should
be conducted through bfinance and should be for an initial investment
for £20 million with the option to extend this to 6% of the total Oxfordshire
Pension Fund.
RECOMMENDATIONS.
- The Committee
is RECOMMENDED to:
- invest
an initial sum of £20 million in a private equity fund of funds
with the option to extend this to 6% of the total Oxfordshire
Pension Fund over the longer term;
- appoint
bfinance to carry out the tendering arrangements;
- request
officers and the Independent Financial Adviser to short list,
interview and appoint an appropriate manager or managers, having
regard to achieving a well diversified portfolio in terms of
both geographical and financing stage;
- request
officers to report the outcome of this exercise to the Pension
Fund Committee in May 2006.
SUE
SCANE
Head of Finance
& Procurement
Background
papers: Nil
Contact
Officer: Tony Wheeler Tel: (01865) 815287
November
2005
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