Over a coffee in Sydney, she unpacks the fund’s complex workings. It typically holds a stake in a company for three to seven years, before seeking to exit at a profit. Investments are genuinely diverse, with the targeted return of 10 per cent to 12 per cent per year, after fees.
“We actually had a Chinese fashion doll company [Pop Mart] that just went public,” she says. “They just opened a shop in the Sydney Westfield. A Chinese guy set up the company, straight out of university, and is now a billionaire.
“We found an opportunity to make a co-investment in February 2020, but COVID hit, and we decided to monitor it. We went back, invested in September 2020 when it was scheduled to IPO in December 2020 and our valuation went up five times what we paid. We had to hold for six months post-IPO, but still managed to make 3.6-times our money in less than a year.”
Small is beautiful
Smith jests that although a Chinese doll company may seem an unusual investment and emphasises that the blockbuster return is not typical, she says it shows the advantage of private equity in finding investments that others cannot.
The fund is also unusual in the PE space as it targets smaller companies on enterprise values under $US100 million ($154 million). Other investments include footwear designer and manufacturer Galaxy Universal and restaurant chain, Captain D’s Seafood Kitchen.
“We typically try to sell the companies at a higher multiple,” she says. “We don’t want them to pay dividends, we’d rather they reinvest for growth, and dividends aren’t so tax efficient.”
This approach contrasts to the pandemic era of cheap debt and record liquidity that fuelled a boom in huge private equity deals and brought comparisons to the Barbarians at the Gate stereotype of powerful PE players press-ganging public companies into deals.
In Australia, Sydney Airport, Origin Energy, Ramsay Healthcare, AusNet, Greencross, Healthscope, MYOB, Virgin Airlines and InvoCare have all been acquired or targeted by private equity-backed investors since 2019.
Smith says the zeitgeist is partly an abundance of liquidity from institutional investors such as pension funds, insurers and sovereign wealth funds who increasingly turned to large PE funds to invest on their behalf.
“The really big private equity funds have so much capital to invest and have to compete with each other,” she says. “That’s why they have to look to public markets as some of those [private equity] managers can go and raise $20 billion pretty easily,” she says.
“They have to write big cheques to get that money invested. You could also buy and borrow money really cheaply, lever, and then look to sell to someone else. So, yes, PE did well” in the pandemic.
Schroders’ local PE fund has about $180 million in funds from Australian investors largely directed by financial advisers with a total net asset value of $US1.17 billion ($1.8 billion).
Its strong returns have resulted in about $US30 million a month pouring into the global fund over 2021 and 2022. The investments are mainly in the US and Europe across the consumer, healthcare, industrials and tech sectors.
“Our formula is buy a small company at an attractive price, help it grow, and then exit to a bigger company, or fund at a higher multiple,” says Smith. “In the small buyout market, you may find highly regarded family-owned businesses that have a great reputation in their local market, however haven’t had a fresh set of eyes in terms of expansion plans.
“Private equity can step in and help them expand – this may be through expansion into surrounding geographies, expansion along the supply chain, operational efficiencies, or M&A opportunities. Once the company is larger, it can often be sold to a bigger private equity fund or another corporate in a similar industry for a higher multiple of earnings.”
Smith says the fund is also insulated from the stomach-churning swings often associated with sharemarkets , particularly during an era of volatile interest rates.
“Private equity is an illiquid asset class, the valuation technique is quite different,” she explains. “Future cashflows are discounted at much higher interest rates that aren’t linked to market rates, but linked to the desired IRR [internal rate of return] of investors.
“This means interest rate rises don’t have a direct impact on the valuation methodology of private companies. And, [because] we prefer companies with lower leverage, we’re not seeing a large impact of rising rates on company performance within our portfolio.”
The valuation discipline and targeted IRR means the fund rarely does a deal on a valuation of more than eight- or nine-times a target’s annual EBITDA (operating income).
“That eight to nine times EV/EBITDA multiple, even through the GFC, has been pretty consistent,” she says. “We don’t think it’s going to come off more, we remain disciplined on pricing. If listed multiples fall you shouldn’t buy a private company for a higher multiple. The smaller end of the market that we operate in already trades at a discount to the larger part of the PE market, which itself trades at a discount to listed.”
Schroders’ investment team and deal makers can also arrange more complex transactions for target companies than simple equity stakes.
“With the increase in rates and borrowing spreads, companies are reluctant to refinance at present,” says Smith. “We’re seeing some interesting opportunities to provide financing to some of our core companies at very attractive prices. This may involve a preferred equity investment, with a preferred rate of return at 15 per cent per annum.
“It can be a great way to increase exposure to a company you’re familiar with and has downside protection as the preferred equity tranche ranks senior to the common equity holders.”
Smith cut her teeth in finance at Macquarie Group in Sydney and London for nearly 14 years before switching to Schroders in 2017. Like many of her peers, she wants to see more senior women succeed in the industry.
At Schroders, the money manager’s British chief executive, Peter Harrison, has made diversity, equity and inclusion a key performance indicator for all senior managers. “I like it because I think it has to come from the top,” she says. “I’d love to see more diversity in the market.”
And her advice to anyone starting out in finance?
“The biggest thing is intellectual curiosity and do your job, and do it extremely well,” she says. “And the way I’ve always found opportunities is to talk to other people outside your sphere and offer to help. I never had a set career path, but I found with that curiosity and ambition you find yourself interesting roles.”