Private Equity Investment by Pension Funds

Pension funds make pledges to their members, promising them a particular level of future retirement income. This means they must be risk-averse while simultaneously generating sufficient returns to cover the guarantees. Fixed-income instruments, together with blue-chip equities, make up a large portion of pension portfolios. Pension funds are increasingly looking for additional returns in real estate and alternative asset classes, albeit these assets still make up a modest portion of their overall portfolios.

Private equity is a long-term, alternative investment category appropriate for experienced investors. Basically, private equity refers to controlled pools of money invested in the stock of privately owned businesses with the goal of selling the assets for a profit. Private equity fund managers charge high fees in exchange for promises of above-market returns. Institutional investors, such as pension funds, and accredited investors participate in it. Furthermore, pension funds are one of the most important sources of money for private equity firms.

The total assets of pension funds in the United States amounted to $35.5 trillion in 2020, and this number has been increasing from $17.9 trillion in 2010 with a CAGR of 7.1%.



Total Assets of Pension Funds in the US From 2010 to 2020 (Trillion USD)

Source: Pension Markets in Focus 2021 (OECD)


In the first half of 2021, private equity assets under management (AUM) hit an all-time high of $6.3 trillion, up 37.7% over the previous year, whereas private markets AUM reached $9.8 trillion, 33% higher than the year before. Private equity AUM amounts to roughly two-thirds of all private market assets, which also include real estate, private debt, natural resources, and infrastructure. A little more than half of private market AUM is invested in North American-focused firms. Europe and Asia are virtually equal in terms of private market AUM, with 21% and 22%, respectively – a stunning parity considering that Asia's part was just 60% of Europe's six years ago.

In 2021, the American Investment Council examined 178 public pension plans in the United States, representing almost 34 million public sector employees and retirees, and found that 85% of them had some private equity exposure.



US Public Pension Funds Investments Returns by Asset Classes (Based on 10-year Median Annualized Returns)

Source: 2021 AIC Public Pension Study


As we can see from the graph above, private equity investments outperform other asset classes. On a dollar-weighted basis, public pension funds in the United States invest 9% of their assets in private equity (this indicates the chart below).


US Public Pension Funds Portfolio Allocation

Source: 2021 AIC Public Pension Stud


North America is the largest region by number of pension funds and their AUM, accounting for 41.7% of all assets, followed by Asia Pacific (27.5%) and Europe (27.5%). 4 out of 10 world’s biggest pension funds are located in the United States and 2 are in Japan.



Top 10 Public Pension Funds by TotalAssets

Source: Top 100 Largest Public Pension Rankings by Total Assets



Pension funds have boosted their allocations to alternative asset types, particularly private equity, in recent years. Given the relatively low returns of traditional investment assets and the deficit of public shares and bonds in most capital markets that raises prices and cut yields, the theoretical investment case for these allocations is reasonable. But pension funds must take into account the higher risk of private equity compared to traditional financial instruments. Pension funds are one of the most important sources of money for private equity firms.

One of the ways to keep balance while investing in private equity is to apply alternative data actively. The efficiency of alternative data depends on the amount and techniques that are used for its assessment. While hiring a dedicated team of data and market analysts and Machine Learning specialists for most pension funds will be rather inefficient, such entities tend to collaborate with specialized entities. This gives pension funds feasible ways to optimize their investment process.



It’s important to understand that while data analysis is the core of any market analytics, not all entities tend to provide data science-related approaches, especially for those cases when alternative data aggregation and assessment are needed. Yet, we believe that further cooperation in these areas will be beneficial for pension funds.