Australia: The State of Private Equity
By Nathan Cahill, Head of Alternative Investments, Minter Ellison
Posted: 9th July 2015 11:33
2015 has been an interesting year for private equity in Australia with fundraising and investor activity in Australia and broader Asia creating some strong new themes and trends.
The Economic Backdrop
The Australian economy has been operating in a post-resources boom environment of subdued economic activity and low interest rates. Private equity has enjoyed in the past decade the fruits of substantial investment in the resources sector. Many outstanding deals were done in the mining services sector and other support industries such as equipment hire groups. The downturn in resources driven in part by plummeting iron ore and oil prices has left the sector with tapering investment. Ultimately this has meant higher unemployment and the construction sector has been slow to fill the gap left from tapering resource sector investment. The low interest rates and foreign investment has fuelled inflated asset prices and what some are calling a 'property bubble' in some cities like Sydney and Melbourne has started to fuel a strong real estate sector.
Regulation of private equity in Australia has been relatively stagnant save for two areas creating headaches for investors in private equity and general partners:
Fee pressure – there has been substantial government pressure to reduce fees born by superannuation investors. One of the tools to increase this pressure is compulsory greater fee disclosure. The disclosure regime applies standard reporting across all asset sectors which has the effect of making private equity look incredibly expensive. This is because fees are measured against invested capital and not committed capital which can produce fee loading disclosure of 20% per annum for a fund that charges 2% management fee and has only called 10% of committed capital. This is driving fee downward pressure and alternative fee structures.
Portfolio holding disclosure– superannuation funds are required to disclose their portfolio holdings. This has the effect of such funds requiring general partners to agree to provide data even at a portfolio company level. This has meant a number of large investors being rejected by local and foreign general partners who will not disclose such information. We are hopeful that government will shortly approve exemptions for private equity and hedge funds in this regard.
Fundraising temperature– it’s been a year of el nino weather extremes in fundraising. At the hot end a number of general partners raised quickly and with ease – with a number of first and final closes and no funds we have been involved in going beyond a second close. At the frosty end of the spectrum, those with deal issues or depleted investor bases have sadly not been able to raise.
Money sources – Australian superannuation funds have been continuing the trend of investing globally and each backing only a small number of local general partners. However, the money lost to offshore destinations has been more than made up for by foreign investors who have been enjoying strong returns from Australian general partners. We are seeing local investors popping up on the registers of many leading offshore general partners. High net worth money has been flooding into the Australian market from both Australia and broader Asia. Recent changes to Australia's significant investor visa programme mandates an allocation to Australian venture capital or private equity funds which is expected to continue to drive high net worth investment.
Venture capital– it is true that the old VC model in many investors' eyes is gone unless you are a Sequoia (US) or similar with long decent track records. However, there have been some great fundraises for those Australian VC general partners with a unique angle, track record and a different investment model. Carnegie, Airtree and Brandon are all great examples of decent fundraising and deals. Fintech and biosciences has been all the vogue. Investors are now looking for investment models that allow them to greater share in the value curve than the traditional blind pool fund has given them in the past. Brandon as an example as been able to do this with a very strong raising in 2015 from major Australian superannuation funds.
Investors want assets– we have been involved in a number of transactions where the more innovative super funds like Sunsuper and HostPlus are buying assets from general partner funds. They want long term assets particularly those that are protected from tech disruption and perform like infrastructure assets. Examples of such assets are pub portfolios, caravan park businesses.
So what is ahead for us in 2016?
We don't have to reach too far for the crystal ball because the following is already upon us and gathering momentum.
Coinvestments – with fee pressure on super funds, coinvestment deals are gathering momentum. We are seeing a number of super funds step back from fund structures and looking to invest under a mandate structure and in some cases moving to non-discretionary mandates. Whilst in Asia it is quite common for fee free coinvestments, the desire for coinvestment flow has meant many coinvestors are more than prepared to pay fees on coinvestment deals.
Capacity– investors are looking for long term relationships with general partners and as such general partners need to be able to solve the issue many super funds have which is that their fast growing capital base is creating deployment challenges and distorting returns. A number of funds will reach AUD100 billion in size which means for efficient investment they need to write private equity cheques of AUD100 million or above. To this end, if general partners can talk to filling investor capacity requirements in a cost effective manner – without strategy drift – they will find a willing audience.
Fundraising – there are a number of top quality Australian and Asian general partners coming to market for what will be a strong year of fundraising.
Returns from Australian private equity have continued to outperform other asset classes (source: AVCAL, 2015) and with relatively benign economic activity and potentially choppy equity markets, the ability of general partners to drive value through market cycles should make private equity look even better in 2016.