Pension investment in private equity

Pension investment in private equity started in the United States and Canada in the late-1970s,[1] an era of high inflation and mediocre performance for most listed equity markets, when large institutional investors began to diversify into “non-traditional” asset classes such as private equity and real estate.[2]

The trend towards increased allocation to private equity including venture capital accelerated after 2009-2010. At the start of the Great Recession, European and Canadian financial economics experts notably from the World Pensions Council estimated that:

"the crisis would usher an era of durably low interest rates, pushing more pension and insurance investors to pursue a ‘quest for yields,’ increasing mechanically their allocation to non-traditional asset classes such as private equity"[3]

The traditional drivers of pension investment in private equity include statistical diversification stemming from partial decorrelation to listed securities (‘listed equity’ i.e. stocks and also bonds), expectation of superior risk-adjusted returns over long periods (typically 8 to 10 years), access to early-stage industries and fiscal incentives for investments in SMEs and/or innovative technologies.[4]

Research conducted by the London Business School Coller Institute of Private Equity (CIPE) suggests that for most pension investors “private equity and publicly-listed stocks are viewed as [...] substitute[s]... [there is] a strong negative relationship between quoted equity and private equity allocations”.[5]

Large pension funds typically have long-dated liabilities (longer than those of other institutional investors such as banks or insurance companies). They have a generally lower likelihood of facing liquidity shocks in the medium term and thus can afford the long holding periods required by private equity investment.[6]