Obscure and undeveloped just a few years ago, international private equity has blossomed into one of the hottest areas in alternative investments.
A November 1995 survey by Goldman, Sachs & Co. and Frank Russell Capital Inc. underscored the growing interest. In that survey, institutional investors had 5.8% of their alternative investment assets in international private equity; in 1992, virtually nothing was in that sector. In dollars, those surveyed had committed about $3.3 billion to international private equity investing.
And the survey showed international private equity is considered "very attractive" by more pension funds than any of seven other alternative investment categories.
The sector has mainly attracted only the nation's largest pension investors. Among them: the $13.5 billion pension fund of GTE Corp., Stamford, Conn.; the approximately $25 billion Oregon Public Employes' Retirement System, Salem; and the $7.4 billion San Francisco City & County Employees' Retirement System.
To Donald J. Harty, a managing director of Frank Russell Capital, Tacoma, Wash., "expected higher returns are the most compelling reason" investors are turning to the sector.
Respondent to the Goldman/Russell survey expected alternative investments overall to return an average of 15% a year over the next three years, but they predicted international private equity would return 18% annually over the same period.
More investment choices available
In addition to expected returns, industry players say the availability of more international private equity investment vehicles has contributed to the increasing popularity. And, overseas markets in general are looking more attractive these days.
"Because of all the money raised domestically ..... there is a perception and reality that the need for private equity (is greater) overseas," said Brooks Haden, director of private markets research, Strategic Investment Solutions, San Francisco.
Where is the money going? The Goldman/Russell survey showed 64% was allocated to developed markets and 36% to emerging markets. Among developed markets, Europe claimed the 91.6%. Within emerging markets, Asia-minus-China attracted 61.7%; China drew 20.2%; and the remainder went to Latin and South America (11.9%), the former Soviet Union (3.2%), and Eastern Europe (1.4%).
Investors, meanwhile, are employing a range of strategies.
GTE is now committed to "four or five different (international private equity) deals," mainly in Southeast Asia, said John Carroll, president of GTE Investment Management Corp., which oversees the pension fund. Mr. Carroll cited the compelling economic growth in that region.
Of GTE's approximately $1.3 billion in alternative investments, about 20% is outside the United States, said Mr. Carroll. He did not identify the investments.
Oregon PERS has committed $200 million to international private equity, although not all of that has been invested, said Jay Fewel, senior equities investment officer. Oregon committed $100 million to Hancock Venture Partners Inc.'s two international private equity funds - $25 million to the first and $75 million to the second. The pension fund also committed $50 million each to Doughty Hanson & Co. and CVC Capital Partners, both in London.
Seeking returns, diversification
Oregon has been looking for diversification as well as returns. While the Hancock funds offer broad geographic diversification, the Doughty Hanson and CVC commitments are both for buy-out funds targeted to Europe.
"We wanted to look at the developed world first," Mr. Fewel explained. "I suspect that the next ones will be in Asia."
The San Francisco City & County fund, an international private equity investor since 1990, invests opportunistically.
"If the right opportunities appear, the board has been willing to consider them positively," said Clare Murphy, chief executive officer. The fund has invested about $46 million in international private equity, but has no set allocation.
San Francisco's commitments include an Asian fund, two country-specific European funds and Hancock's second international private equity fund.
Not all jumbo funds are signing on. Richard Coffey, director of private equity for the $33 billion Pennsylvania Public School Employes' Retirement System, Harrisburg, said the fund's board of trustees "wanted to see (the international) market mature more. (They felt) there was still sufficient opportunity in the domestic market." For funds that are interested in international private equity, the investment options have certainly exploded.
James D. Seymour, a vice president of The Common Fund, Westport, Conn., says his organization now has a data base of 225 different programs from about 175 managers outside the United States.
Look carefully at new players
He cautioned, however, that a lot of the firms are new. That means "investors need to look carefully at them," he said. Mr. Seymour predicts "less than half will successfully provide the returns they (projected) when selling the product."
Among the deals being done, Endowment Advisors Inc., a companion organization to The Common Fund, recently made a commitment of undisclosed size to CVC European Equity Partners, managed by CVC Capital Partners.
The commitment was made for Endowment Advisors' new International Private Equity Partners, a fund of funds of which CVC is the first manager.
The $250 million Hancock International Private Equity Partners l fund invested largely in 24 partnerships around the world, according to D. Brooks Zug, managing general partner of Hancock Venture Partners Inc., Boston. The firm's second international fund-of-funds closed April 30 with about $950 million.
According to The Private Equity Analyst, the second Hancock fund already chose managers for about a quarter of the money raised. They include; Advanced European Technologies, Munich, an early stage technology-oriented venture capital firm; Doughty Hanson; Phildrew Ventures, London; Schroder Ventures, London; Ciclad SA, Paris; ASC Equity Pte., Ltd., Singapore; H&Q Asia-Pacific Ltd., Taipei; Latin America Enterprise Fund L.P., Miami; and First Corp. Capital Investors Ltd. and CZ Ltd., both of Johannesburg, South Africa.
Hancock diversifies by manager
Hancock's approach is to "build a diversified portfolio of what we considered to be the private equity managers with the strongest track records," said Mr. Zug.
"We look toward the underlying strengths of managers first and foremost," then at the "strengths of particular countries." That includes he health of the local stock markets, expected to be important exit vehicles for the private investments.
Although emerging markets are attracting some investors, Hancock still focuses heavily on the developed markets. So does Pantheon Ventures Ltd., London, another international private equity fund-of-funds manager.
"It's hard to find private equity teams with track records in emerging markets because the institutional private equity business in that area is very new," said Hancock's Mr. Zug. "We saw a surge of interest in China in 1993 and in India after that. But we chose not to invest in those vehicles because there is more than the normal level of risk in them. While we will invest there at some point, we want to wait long enough to see where the money can be made."
Added Rhoddy Swire, Pantheon's group managing director: "Pioneers end up with arrows in their backs. I would argue that pension funds in private equity would do well to diversify - to cover all regions where there is a mature private equity market. We need to understand those emerging markets."
