With the dust still settling after World War II, British policymakers began to turn their attention to what had been called “a chronic shortage of long-term investment capital for small and medium-sized businesses.” The result was the Industrial and Commercial Financial Corporation (ICFC), a pool of capital funded by major British banks. Fast forward to July 1994, and the successor to the ICFC – now known as “3i” became one of the first private equity funds to be listed on an exchange.
Since then, many other private equity funds have listed themselves – most notably in the UK. In fact, one might even say that listed private equity funds have blazed a trail for the recent wave of hedge fund ETFs.
A new study of this branch in the private equity family tree sheds light on which types of institutional investors allocate capital to these funds, and why they have grabbed the attention of investors. The paper, by Douglas Cumming of Canada’s York University (see related post), Grant Fleming, a visit professor at the Australian National University, and Sofia Johan of the Tilburg Law and Economic Center, examines the private equity allocations of 100 European institutions and finds that 43% invest in listed PE funds – allocating an average of just over 6% of their capital to them.
As you can see from the chart below (created with data from the paper), organizations that invested in listed PE made extensive use of consultants. In addition, they were the only PE investors to use their existing equities teams to manage the allocation. As the authors suggest, this is likely because listed PE funds are, technically speaking, listed equities.
In addition, listed PE investors were more commonly private pension funds, rather than public ones. According to the paper, part of this could be due to the smaller size of private funds – and therefore their smaller capacity to conduct due diligence on LP investments.
One of the problems with traditional (LP) PE investing is that capital may be deployed quite slowly as the GP searches for investment opportunities. As a result, full PE exposure may not be reached until several years after the initial capital commitment is made. To compound this problem the time line for ramping up this exposure is in the hands of the GP, not the LP.
As the paper points out, listed PE funds allow institutional investors to get PE exposure immediately. And in fact, institutions seem to take advantage of this benefit. Those that invest in listed PE are 15% more likely to adjust their allocations over time. In addition, listed PE investors are 9% closer to their desired private equity allocation compared to institutions that invest using LPs.
In conclusion, Cumming, Fleming and Johan suggest that listed PE may be a growing asset class as defined benefit plans switch to defined contribution plans and put decision-making into the hands of unit-holders themselves.
Which makes us wonder if hedge fund ETFs may ride the same tail wind…