AustralianSuper announced last year its plans to double its private equity exposure over the next five years. The Future Fund is speaking of a “new investment order” and has already increased its private equity exposure to $34.5 billion or 17.5% of its portfolio. With institutions going big on private equity, what does this mean for individual investors and self-managed superannuation funds?
Private equity seems to be on the lips of nearly every investor these days. With AustralianSuper doubling its private equity exposure over the next five years and the Future Fund speaking of a “new investment order”, institutions are increasingly using the world’s largest fund managers to help them build diversity into their portfolios and find outperformance. One cannot help wonder where it leaves the rest of us in building our own investment portfolio.
It is not hard to see why some of the largest institutional investors are excited about the potential of private equity:
“The most in-depth research continues to affirm that, by nearly any measure, private equity outperforms public market equivalents.” ~ McKinsey Global (2021)
It is no secret that institutions and the ultra-wealthy have for years been turning to the world’s leading fund managers seeking to strengthen their investment portfolios. These institutions – which include sovereign wealth funds, insurance companies, superannuation funds, endowment funds, and foundations – have been using select exposure to leading private equity funds to inject diversification, potential outperformance and, perhaps the most sought-after goal, uncorrelated returns into their investment portfolio (uncorrelated to listed equities).
These institutions turn to the largest fund managers in the world for help from the likes of The Blackstone Group, KKR & Co, Brookfield, CVC Capital Partners, PGIM, Apollo Global, among others. These firms bring scale, expertise, resources, and long track records to the task of building funds made up typically of opportunities from hard to source private market opportunities, to drive risk-adjusted outperformance to their institutional clients.
The pull of private equity
The pull of private equity has only become stronger over recent years. Part of the reason has been the outperformance relative to listed equity markets. When Cambridge Associates compared Australian PE / VC managers in aggregate with the ASX 300 on a public markets equivalent basis, it demonstrated robust returns over the long term (see Figure 1). Australian PE / VC managers also remain competitive when compared to their peers in the US (Figure 1, which is in local currency terms).
Australian PE / VC & Global PE / VC peers (local currency)
Private equity has often been described as patient money. It invests for the long-term, often ten years or more, and is illiquid meaning it is difficult to exit early. Instead of daily pricing, the pricing of the underlying assets is much less frequent. This takes some of the heat out of short-term investor sentiment. Like baking a cake, it is not always good to open the door to check how it is going.
As there is generally higher risk and illiquidity associated with private equity funds, we would generally expect to see additional returns of +3 to +5 percentage points over listed markets over the long term (i.e. a risk and illiquidity premium)*. The above table demonstrates historically that both the local and US public market equivalent indices calculated by Cambridge Associates have achieved more than the long term expected risk and illiquidity premium.* (*Past performance is not indicative of future performance. Specific risks may impact the possibility of such a return in future).
In McKinsey Global’s analysis, the outcome is the same:
“The most commonly accepted measure of private equity performance, public market equivalent …performance… finds that, of the 20 vintage years between 1996 and 2015, buyouts in only one vintage year (2008) have underperformed their respective public market equivalent return. This finding holds mostly true whether measured against the S&P 500 or the Russell 2000…”
With uncertainty on the horizon, we have seen an indication from institutions that they are going to double down on their private equity exposure to ‘eke out’ hard to come by performance.
This wave of interest in private equity and its potential has already started to wash up on Australian shores.
The Chairman of the Future Fund, explained to the AFR last year that the Future Fund would continue to allocate more money to private equity as institutional investors continued to take more public companies private in order to deliver higher returns:
“Returns are just going to be much lower, and you’re going to have to think carefully how to eke them out.”
The endowment model
Many Australians have grown up with the traditional 70:30 ratio for investment portfolios between shares and bonds.
The purpose of bonds, so the thinking goes, is to function as a defensive anchor, relying on a negative correlation between the two asset classes, while providing yield (even if low). While this has been the assumed wisdom, as noted by the Future Fund, the world looks very different now:
“…nominal bond yields are significantly lower so the scope for bonds to pay off is reduced. Investors have ended up paying to benefit from bond rallies rather than being paid. If inflation begins to rise, the bond-equity correlation may prove much less beneficial going forward.”
With access to private equity, institutions on the other hand have had an ace up their sleeve. They have been building less traditional investments into their portfolios over the last 20 or so years. The ‘endowment model’ approach maintains low liquidity with long-term investments in private equity and incorporates a lower percentage of bonds than the traditional 70:30 model suggests. Globally, some 14-15% of assets held by endowment funds or foundations are allocated to private equity.
While not without its critics, even more, conservative superannuation funds have been playing catch up in recent years, with 7-8% of assets also invested, with that likely to increase over the next 5 years.
In the race of institutions to deploy more capital into private equity funds, and a growing interest in using these funds to take public companies private (à la AGL, Ramsay Health Care, Crown Resorts and AMP to name just a few Australian examples), where does this leave Australian families building their own nest-egg?
In the words of Mr Costello: “How does your mum or dad get access to a private market? They can’t.”
Democratisation of private capital
Over the last 40 years, the rise of technology has transformed public markets. We have gone from bearer share certificates held in the vaults under the floor of the New York Stock Exchange to Robinhood, a technology company providing commission-free trading through a mobile app.
The wave of digitisation has brought with it a democratisation in terms of access. However, as private equity takes major public companies private, concerns are raised for our “shareholder democracy”. Access to private markets has historically been constrained even for institutions and certainly not open to individual investors. As a result, or perhaps because of it, many of these institutional-grade funds require a minimum cheque size of US$10m. However, the opening of access to private markets has started overseas and is now coming to Australian shores.
The growing demand on the part of individual investors to reach private market funds is matched by fund managers keen to diversify their fundraising base. Apollo Global Management recently noted that the estimated global market for high net worth investors comprises US$178 trillion, well in excess of the $102 trillion in the hands of institutional investors.
What is next for Australian investors?
Australia is well-placed to take advantage of this growing demand. Australians have already embraced the emergence of new platforms that offer access to a range of ‘alternative assets’. On these platforms, you can own a piece of Banksy or crowd-fund a craft gin company. However, access to private equity, particularly pure institutional-grade funds run by the largest fund managers in the world, remains elusive.
The successful opening of this market requires careful planning and better educational resources to help investors. These products are not like listed equities, they have long tenures, often with no liquidity until exit. Opening this new investment class must be supported by technology and education to raise awareness or temper some of the hard edges of private equity.
At Reach Alternative Investments, our vision is to democratise the world’s leading private capital funds, allowing Australian investors the same level of access and support that an institution receives. We want you, with the help of your financial adviser where needed, to be able to access and build your own investment portfolio that suits your needs and stage of life.