Sunday, December 03, 2006

Private Equity - Less of an "Alternative"

Retirement plan fiduciaries have been confronted by a host of new fiduciary issues over the last few quarters. PPA, SFAS No.158 & excessive fee litigation have been widely addressed. Less recognized are some significant capital market trends that promise to have a growing impact on investment fiduciaries. Among others, substantial innovation in the derivatives market is adding complexity, uncertainty and risk to the fiduciary oversight process. The rapid development of private equity markets will also influence the investment opportunity set that retirement plan fiduciaries must consider providing and monitoring for their plans and participants.

The Committee on Capital Markets Regulation, an independent, bipartisan committee composed of leaders from business, finance, law, accounting and academia just released a study concluding that the US capital markets are becoming less competitive due to excessive regulation, enforcement and class action litigation. The dramatic increase in the use of private U.S. markets is indicated by these study statistics.
  • 5% of the value of worldwide initial public offerings was raised in the U.S. last year,versus 50% in 2000.
  • the U.S. share of total equity capital raised in the world’s 10 top countries has declined to 27.9% so far this year from 41% in 1995.
  • private equity firms, almost non-existent in 1980, sponsored more than $200 billion of capital commitments last year
  • since 2003, private equity fundraising in the U.S. has even exceeded net cash flows into mutual funds and going private transactions have accounted for more than a quarter of publicly announced takeovers.
The benefits of private equity investing are addressed in an Update by the Center for International Securities and Derivatives Markets.
"Private Equity is generally regarded as an investment which offers investors the opportunity to achieve superior long term returns compared to traditional stock and bond investment vehicles. The long-term high returns of private equity represent a premium to the performance of public equities. Private equity provides higher return opportunities relative to traditional asset classes primarily through their ability to participate in a vast and growing marketplace of privately held companies not available in traditional investor products as well as their ability to create value by proactively influencing invested companies’ management and operations, thereby providing the opportunity to gain excess return over conventional stock and bond investments."
A substantive competitive decline in the US public capital markets would certainly have financial and economic implications that should be considered in future fiduciary decisions on market and asset class opportunities. Moreover, an increasing share of global capitalization allocated to private equity may particularly disadvantage defined contribution plan investors which generally can't access this asset class. As private equity becomes an accepted component of modern portfolio building practice by pension plans, endowments and other “qualified” investors, DC plan fiduciaries may in the future find it imprudent not to provide access to some level of private equity investment.

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