Pension funds should invest in private markets, says venture capitalist

Founder of venture capital firm Lakestar, Klaus Hommels, believes European pension funds and insurance companies should be able to invest in private markets such as venture capital funds, to enable European startups to have more growth capital at their disposal.

The EU has long tried to increase the size and strength of its capital markets as its relative weakness compared to the US is seen as a reason why Europe hosts less successful startup companies.

In the EU, companies are much more reliant on banks than private markets for financing, making the financing environment more cautious and risk-averse than in the US.

“While Europe has a strong talent base, it is often missing out on successfully commercialising and scaling innovation due to a lack of capital available at certain stages of growth,” Hommels told EURACTIV.

And many EU leaders agree. “Businesses, especially SMEs, are struggling to find the patient and risk-bearing funding they need to invest in the green and digital transition,” the presidents of the European Council, the European Commission, the Eurogroup, the ECB, and the EIB wrote in a joint opinion piece.

According to estimations by the EU Commission, the EU needs additional investments of around €520 billion to achieve a successful green transition. And the tense discussions around enabling more public investments into the green transition suggest that much of this investment must come from private investments.

Under the Capital Markets Union (CMU) umbrella term, the EU is slowly trying to remedy this lack of private capital through various regulatory initiatives. Most recently, in March this year, for example, EU lawmakers agreed on a reform to make investing easier in European Long-Term Investment Funds (ELTIF).

Hommels has his eyes on pension funds and insurance companies that wield enormous balance sheets.

“To increase the amount of growth capital in Europe, the continent must enable large pools of money, such as pension funds or insurance companies, to invest in the private markets at a broader scale,” he said, arguing that the US system where pension funds allocate a larger part of their portfolios to riskier and more illiquid investments brought better results than the European system.

As a venture capital firm’s founder, Hommels would benefit if the large capital pools of pension funds and insurance companies were unlocked for alternative investments like venture capital and private equity funds.

According to data from the ECB, euro area pension funds held total assets worth €3.123 billion at the end of 2022, so there is a large pool of potential alternative investments.

However, channelling pension fund money to alternative investments, like private equity and venture capital, is also risky. The investments are generally riskier and less transparent than a simple index fund.

Moreover, management fees are higher in these alternative investments, leading to questions about whether pension fund money should go towards highly paid managers of alternative investment funds when equity index funds often offer similar performance at a lower price.

In the US, for example, the State Teachers Retirement System of Ohio was criticised for having paid over $4.1 billion in management dees for alternative investments while cutting back cost-of-living adjustments due to underfunding.

Regarding the assets of insurance companies, Hommels called for enabling insurance companies to invest more in long-term equity in the context of the ongoing review of the Solvency II regulation.

Solvency II regulates how much capital insurance companies must hold to ensure financial stability. The EU Commission proposed a review of the rules in late 2021. Currently, the file is stuck in negotiations in the European Parliament.

The following small step towards a Capital Markets Union will likely come on 3 May, when the EU Commission is expected to present its Retail Investor Package.

[Edited by Alice Taylor]

More on the same topic…