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Why pension funds need to invest more in private equity

Obstacles complicate Retirement Benefits Authority’s (RBA) long-term plan of reaching 10 percent of pension assets allocated in private equity
Obstacles complicate Retirement Benefits Authority’s (RBA) long-term plan of reaching 10 percent of pension assets allocated in private equity. PHOTO | COURTESY 

The National Treasury proposal to subject private equity (PE) firms that tap public funds (read pension schemes) to Capital Markets Authority (CMA) regulations, are welcome – if that’s what it takes to open up pension fund coffers.

Otherwise, regulatory hurdles at this early stage are unwelcome.

More obstacles complicate Retirement Benefits Authority’s (RBA) long-term plan of reaching 10 percent of pension assets allocated in private equity. And ultimately, small and medium enterprises (SMEs) stand to lose. But we give the government the benefit of the doubt.

So, why should pension funds invest in private equity?

First of all, today, more companies are choosing to stay private. Due to high levels of capital allocated to the private equity funds, small firms no longer need to go public to access capital.

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As a result, SMEs can get to focus on improving their businesses without the quarterly-and-half yearly reporting requirements and other pressures of being a listed company.

They also get to avoid markets short-termism. Secondly, as with all investing, it is wise to maintain a diverse portfolio. Pension funds, like all portfolios, benefit from holding assets that provide diversification.

Currently, pension assets investments in private equity account for less than one percent of the total pension assets estimated at Sh1.2 trillion. Lastly, pension funds are among the most obvious candidates to invest in this asset class, given their targeted returns and liquidity requirements.

Crucially for SMEs, the “equity gap” can be narrowed. This “equity gap” arises where SMEs with viable investment propositions are unable to attract investment due to a number of factors, such as sector, stage of development and location.

It is precisely these situations, which the pension funds can help address indirectly. According to the 2016 KNBS MSME survey, less than six percent of licensed SMEs surveyed sourced capital from banks while over 70 percent obtained it mainly from family.

The study also showed that almost half (45 percent) of new MSMEs shut down within a year of operation with the main reason for folding being shortage of working capital. Only about five percent of SMEs survive to celebrate their 10th anniversary.

For inspiration, local pension funds can look at more experienced jurisdictions. In Europe for instance, pension funds provided the most funds (31 percent) of all capital raised and investments made in the private equity European space, according to European Private Activity (2018).

Funds of funds & other asset managers followed at 18 percent, family offices and private individuals (11 percent), insurance companies (11 percent) and sovereign wealth funds (nine percent). In the US, pension fund investments in private equity are estimated at over Sh30 trillion.

In all, the idea is to encourage local pension funds to operate in a part of the market which presents mutual benefits. With an average fund life cycle of 8-10 years, it is the long-term nature of private equity that makes it a particularly well-suited investment for pensions.

More importantly, as the rise of the gig economy and informal entrepreneurship pose the risk of underfunded schemes, pensions must continue to invest in private equity.

Mwanyasi is MD, Canaan Capital Ltd

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