Tyne and Wear switches PE benchmark to limit relative volatility

The £5.7bn scheme has moved to using an absolute return benchmark of 8 per cent net of fees, rather than one based on a global equity index, according to the scheme’s 2013/2014 annual report.

Institutional investors have faced scrutiny for not using asset index benchmarks, with performance review provider Clerus arguing they hide £1.1bn of annual underperformance across the Local Government Pension Scheme.

Tyne and Wear has £548m invested in private equity and the change has been backdated to the start of the private equity programme. 

Private equity typically involves substantial degrees of leverage and if you lever up the FTSE All Share … you would have made very handsome returns

Phil Irvine, Pi Rho Investment Consulting

The report stated: “This long-term benchmark has been adopted to seek to reduce the volatility of returns relative to the benchmark. It is believed that this approach reflects the approach to the valuation of the assets more appropriately than the use of an index-based benchmark.” 

The new benchmark is in excess of the longer-term return expected from global equities, it stated. 

Karen Shackleton, managing director at AllenbridgeEpic Investment Advisers, said it can be difficult to assess the performance of private equity investments due to the closed-ended nature of the funds and because independent, daily valuations are not available.

She said it can be more effective to take a more holistic approach to assessing whether a manager’s approach is working. 

“Together with the manager [look] at their six-monthly reports or quarterly reports in terms of assessing in advance what they would expect in terms of investments that would be on track, hit your expectations or perhaps with issues,” said Shackleton.

Shackleton said using global equity performance as a benchmark is a more long-term marker to be used over a full economic cycle.

The scheme also switched to using the forecast return on assets held by the fund to derive the discount rates for the 2013 valuation.

Its funding level improved slightly to 81 per cent at March 31 2013, using the new discount rate, up from 79 per cent at the same time during the 2010 valuation.

Phil Irvine, director at PiRho Investment Consulting, said monitoring private equity can be difficult in the first 18 months to two years.

To do this schemes can assess whether their manager has invested the proportion of money that they said they would in that period, and whether they have accessed types of investment opportunities they had originally proposed.

Irvine said managers often make the case that private equity offers very steady returns, but schemes need to factor in the risks involved. 

“Part of that is just because it’s not being priced that frequently so in some ways it’s a substantial level of risk,” he said, adding schemes also need to be aware of the impact of leverage in private equity performance.

“Private equity typically involves substantial degrees of leverage and if you lever up the FTSE All Share … you would have made very handsome returns,” he said.