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© Copyright 2002
Rogers Media. The following article first appeared in the March 2002 edition of
BENEFITS CANADA magazine.
Pension Planning
The role of private equity
The Canada Pension Plan Investment Board is one
of this country's largest investors in private equity. What can this asset class
do for your fund?
By Mark Weisdorf
 Over the next few years, the Canada Pension Plan
(CPP) Investment Board will emerge as one of the largest domestic investors in
private equity, with as much as 10% of total assets in private equity. Within 10
years, the board expects to manage more than $130 billion in total assets,
compared to $14 billion today. If the 10% target is maintained, it will have
private equity investments of approximately $13 billion, with commitments
exceeding $20 billion.
This is a large pledge--although not by U.S.
standards, where private equity commitments among pension funds exceeded US$200
billion in 2001. With the exception of CDP Capital Inc. at over 10%, the next
big five Canadian pension funds have less than 5% of their total assets invested
in private equity.
ENHANCED RETURNS
So why is the board
committing so much so soon? Because over time, private equity will outperform
public equity by 2% to 5% a year. That is an enormous difference for any pension
fund committed to maximizing risk-adjusted investment returns.
Private equity investments may also help defined benefit plans reduce the
risk of contribution rate increases and improve pension benefits. Additional
returns could help the corporate treasury keep the plan fully funded.
The 2001 Goldman Sachs Frank Russell survey on alternative investing found
that the private equity allocations of 176 tax-exempt North American respondents
averaged 7.5%. The rate was slightly lower (6.5%) for those with assets of less
than US$5 billion.
This begs the question of whether your pension fund should invest in private
equity, and if so, how much and in what markets? Important considerations
include the size, risk tolerance and maturity of the fund. The CPP Investment
Board is not required to return any income to the CPP for at least 20 years. It
can afford the patience that private equity investing requires. Investments made
today may not realize their full value for 10 or 12 years.
Still, even a mature plan might choose to include private equity in its
portfolio. Public equity and fixed-income securities provide the liquidity
required to meet the growing pensioner payroll, while private equity investments
could earn superior returns to help meet the future needs of younger workers.
The more difficult issue for smaller pension funds is how to invest in
private equity. Many plans have neither the time nor the resources to make
informed decisions about an asset class that can be complex and time consuming.
FUND OF FUNDS
One way for small funds
to invest in private equity is through a fund of funds. As the name suggests, an
experienced manager creates a fund that invests in a portfolio of private equity
funds. The result is instant diversification by industry, country and investment
style with the opportunity to earn superior and less volatile long-term returns.
There are many fund-of-fund choices in the U.S. and Europe that accept
commitments of US$5 million. This enables smaller pension plans to gain insight
into private equity and expand their commitments gradually. Canadian funds of
funds are expected to emerge in the next year or so.
Over the long term, private equity has the potential to make a significant
contribution to total portfolio performance and serve the best interests of plan
contributors, beneficiaries and sponsors. For plan sponsors, the value of the
pension plan may equal or even exceed the value of the company itself.
Maximizing investment returns may be critical for an organization to ensure its
own financial survival.
For the CPP Investment Board, the benefits of a serious commitment to private
equity outweigh the risks. Smaller plans interested in diversifying beyond
public equity and fixed-income securities should consider the advantages of this
asset class. BC
Mark Weisdorf is
vice-president, private market investments with the Canada Pension Plan
Investment Board in Toronto. www.cppib.ca.
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