2. Trends in Direct Investment: A Historical Perspective:
2.1 Early institutional investing pre-1880-1980
During this phase, most investments were made directly by institutions, and many of the larger institutions tended to invest in safe, liquid assets such as government bonds. However, some institutions retained large direct investments in real estate, unlisted equities and other assets. In the late 19th century, a few began to appreciate that investing in illiquid, risky assets could reduce risks when the assets were held as part of a balanced portfolio.
Generali’s 1885 decision to start a large, direct real estate investment programme is one of the earliest examples of using direct investments specifically to diversify an asset allocation. Similarly, MetLife credits its decision not to invest heavily in public equities for enabling it to make it through the 1929 US stock market collapse intact. In turn, MetLife was able to use funds from its direct real estate programme to help save the Empire State Building project.9
Other investors of the time chose to invest directly in illiquid assets because this practice was embedded in their historical approach to investing. Many of today’s family offices, for instance, grew out of the investment offices of major 19th- and early 20th-century industrialists. These offices subsequently played a major role in the evolution of the US venture capital industry during the 1950s and 1960s.10 Similarly, the Wellcome Trust, created in 1936 to advance medical research, was for many years the sole shareholder of its founder’s successful pharmaceutical company, and used its experience as an asset owner to develop further expertise in managing direct investments following partial flotation in 1986.
Until the 1980s, however, many larger institutions invested in a more narrow range of liquid assets. Despite the development of modern portfolio theory in the 1950s and 1960s, it was not until the introduction of the 1974 US Employee Retirement Income Security Act (ERISA)11 and its various amendments that most US pension fund trustees felt able to fully diversify their portfolios and make full use of external managers – an approach soon emulated in other countries.
With economic and demographic fundamentals promoting ever faster growth in institutional assets since around 1980, the stage was set for the emergence of the modern asset management industry and for the rise of illiquid assets as a major class of outsourced institutional investment.