As previously reported in Private Equity Comment, pension funds are the largest single source for European private equity and venture capital funds – according to Invest Europe data they have accounted for almost a third of capital raised in Europe in the last three years. And although many are seeking to increase their allocation to the asset class, there are still a number of potential pension fund investors with limited experience and understanding of how these funds operate, which may be holding them back from making investments.

In order to try to assist these potential sources of capital, Invest Europe has launched a guide for pension funds on the mechanics and benefits of private equity and venture capital investing. As well as outlining the basics of how funds are established and how the money is invested, it draws on the views of several large European pension funds who are experienced investors in the sector - such as Ilmarinen Mutual Pension Insurance Company, APG Asset Management, SPF Beheer and Stichting Pensioenfonds TNO. A common theme emerging from the guide is that private equity is a very good match for pension funds: the long-term nature of the returns match the long term liabilities of pension funds far better than listed shares, and the returns achieved generally out-perform those provided by the public equities market over the long term – even if investors apply an "illiquidity premium” to their benchmarks. It is also very difficult for pension funds and other investors to access private equity investments without investing through a fund manager, given the time requirements and expertise that is needed to source and manage these types of deals.

While returns are obviously high on every investor’s list of reasons to invest, the guide also points out benefits such as the alignment of interests between the fund manager and the investors, as well as between the funds themselves and management at portfolio company level. The more volatile public markets can lead to short-term decision-making but, in private equity, the fund manager usually has its own money invested in the fund, and carried interest is only received if and when profits are paid to the investors.

Performance measurement and valuations can be particularly challenging for investors new to the asset class. Valuation of assets for which there is no readily available market is very different from valuing publicly traded stocks and, since there are no appropriate public benchmarks against which to compare returns, investors use a variety of different measures to judge the success of a fund investment. The guide helpfully sets out the different metrics and benchmarks that can be used to judge performance, and also looks at the different methods used by the featured experienced investors.

Overall the guide should prove extremely useful for investors who are unfamiliar with private equity and venture capital as an asset class, and will hopefully encourage additional investment in the sector, allowing more investors to benefit from strong performing, diversified portfolios.