Commitments to alternative investments by the largest pension funds, endowments and foundations in the United States and Canada grew to $91 billion -- a 57% increase -- since 1995, a new survey shows.
The survey -- "Report on Alternative Investing by Tax-Exempt Organizations" -- was conducted by Goldman, Sachs & Co. and Frank Russell Capital Inc.
Since their last report, in 1995, Goldman and Russell found:
Public pension funds have increased their commitments to alternative investments at almost double the rate of corporate pension plans -- 31% vs. 17%. Public fund commitments to alternatives now stand at $44 billion.
The average dollar commitment to alternatives by endowments and foundations more than doubled, to more than $1 billion from $455 million.
International private equity has been the fastest growing alternative investment category -- increasing 60% to 9.3% of total commitments vs. 5.8% in 1995 and 1% in 1992, the first year the survey was conducted.
Net returns in the four major alternative investment categories -- venture capital, leveraged buy-outs, international private equity and mezzanine financing -- matched or exceeded respondents' expectations since the last survey.
The survey examined pension funds, endowments and foundations with total assets greater than $3 billion. Of the 213 organizations in the sample, 154 responded and 119 invest in alternatives.
Committed to alternatives
While smaller funds were not included, the survey suggests they, too, are increasing their commitments to private equity.
Commitments to alternative assets by the 15 largest respondents increased a compound annual 20% between 1995 and 1997. But commitments by all respondents surged 25%.
"The smaller funds (within the survey) are growing faster," said Thomas Healey, managing director with Goldman Sachs in New York.
"What we are hearing is the smaller funds are taking note of what the big funds are doing and they want to play the game," said Paul Kaltinick, managing director at Frank Russell in Tacoma, Wash.
The popularity of international private equity and the ascendancy of public pension funds as investors are the most striking elements of the Goldman/Russell survey.
According to the Goldman/Russell survey, 50% of the respondents indicated international private equity will be the most attractive area for investment in the next three years.
International private equity should exceed 10% of all alternative commitments by early next year, the survey said, thanks to the growing appetite for international investments and the increased number of international alternative vehicles coming to market.
"In the first (survey) there was zero interest in international private equity," said Mr. Healey.
"The last time it was the category with the most change, but it wasn't as popular as this time," he said.
Of the 50% of respondents who were attracted to international private equity, one-third of themsaid the developed markets were attractive and about one-sixth said the emerging markets were attractive.
Latin America is popular choice
Within the overall commitment to international private equity, Latin America showed the largest percentage gain in commitments in the two years between studies, growing to 10.7% of total commitments from 4.7%.
China cooled off during the past two years, dropping to 2% of international commitments from 7.2% two years ago.
Overall, 61.2% of international private equity commitments went to the developed countries and 18.8% went to the emerging countries of Asia, according to the survey.
Mr. Kaltinick said recent economic turmoil in Asian developing economies will slow private equity commitments to funds targeting deals in those countries.
Corporate funds lead way
Corporate pension funds continued to lead the way in commitments to international private equity -- with 8.6% of total commitments earmarked for the category.
But public pension fund respondents surged past their corporate peers in the total amount they committed to alternatives, according to the survey.
Commitments to alternatives by public fund respondents have reached $44 billion, compared with $37 billion by corporate fund respondents, the survey states.
During the past two years, public funds increased their alternative investing commitments by almost double the rate corporate funds did.
Two years ago, corporate pension fund respondents committed a total of $27 billion to alternatives, compared with $26 billion for public pension funds.
Who are fully funded
Many corporate pension funds are fully funded while public pension funds continue to grow, said Mr. Kaltinick.
The bulk of the commitments to alternatives -- 57.2% -- by public pension fund respondents went to leveraged buy-out funds.
Corporate pension funds committed 49.5% of their alternative assets to buy-out funds.
Overall, corporate pension fund respondents committed a greater portion of their total assets to alternative investments than did public pension fund respondents, 7% and 4% respectively.
Overall, endowments and foundation respondents committed the largest portion of their assets to alternatives -- 16.6% of the total assets.
To boost returns
Respondents said they invest in alternatives to boost returns over traditional investments.
They haven't been disappointed, according to the survey.
Actual annualized net returns between 1995 and 1997 for venture capital, buy-out funds and mezzanine financing all exceeded expected returns, the survey states.
International private equity returns matched investor respondents' expectations.
Venture capital returned an annualized 32%; its expected return was 16%.
Returns higher than expected
LBO funds returned 20% vs. an expectation of 17%; international private equity returned 18%, matching its expected rate of return; and mezzanine financings generated an 18% return, compared with an expectation of 11%.
During the next three years, respondents expect annual net returns for alternative investments to be 17% on average, 700 basis points higher than their expected return on the U.S. equity market, the report states.