Private Equity’s Unwelcome Intruder?

Hester Plumridge reports in the WSJ, Private Equity’s Unwelcome Intruder:

The Ontario Teachers Pension Plan has just beaten European buyout firm CVC Capital Partners to the chase to buy U.K. lottery operator Camelot Group. While the £389 million ($576.4 million) deal may be relatively small, it could be the start of a wider trend. Pension funds such as Ontario Teachers are bypassing secondary funds to take charge of equity investments themselves. Their offers of longer-term ownership, and the potential for paying higher prices, could give them an edge with vendors.

Pension funds traditionally invest in companies via secondary vehicles: specialist-mutual, private-equity, sector or index funds. But Ontario Teachers, which manages $87.4 billion of funds, claims to be changing the industry model. Well over half of its $34.9 billion equity investments are made directly in companies. Benefits include eliminating hefty external manager fees, as well as retaining greater control over holdings.

Other funds are following suit. The California Public Employees’ Retirement System, the largest U.S. pension fund by assets with $200 billion, will invest directly up to a third of the $1.3 billion earmarked for infrastructure investments this year.

In theory, pension funds have several advantages over private-equity managers. Pension-fund liabilities, and therefore their investment time frames, stretch to decades, rather than years as is the case with private equity. The promise of long-term ownership swung the Camelot deal for shareholders. Pension funds also may have a lower cost of capital than private equity, as they don’t require a liquidity premium to reflect the cost of locking up money. That may enable them to outbid private equity or run investments with less aggressive capital structures. Escaping private equity’s hefty fees also boosts returns.

Of course, direct investment requires in-house expertise that is both resource heavy and hard to build up, which is why so few pension funds are doing it