Even as several surveys indicate that global asset owners are continuing to increase their allocations to alternative assets, smaller-sized Australian institutions are rethinking their existing investments in this space, especially to private equity.
That’s the view of Martin Goss, director of investments for Australia at Willis Towers Watson.
“There are probably as many people leaving private equity as there are entering the asset class. It’s not been a growth area in Australia [from an allocations perspective],” he told AsianInvestor.
Melbourne-based Goss said many smaller super funds remain on the fence about investing in private equity (PE). “They need to have confidence in the programme and be willing to accept the higher fees," he said.
Funds with less cash flow certainty -- typically retail funds as opposed to industry funds -- and lower tolerance for high fees are the ones moving out, or not making any further allocations, he said.
“The fees and the amount of time management that boards have to commit to the programme - or if they are using a fund of funds, the cost of that programme - has eroded their popularity," he said.
Nevertheless, larger super funds, such as AustralianSuper and HostPlus, are well down the track in terms of alternative and risk premia allocations to supplement their traditional strategic asset allocation -- and continue to favour PE.
Take, for instance, the largest Australia pension investor, the A$140 billion ($103 billion) AustralianSuper. It has a balanced fund with 3.7% in PE that has produced a 17.6% return in the 12 months to June 30, according to its annual results.
Speaking to the Australian Financial Review, AusSuper chief investment officer Mark Delaney said the fund had done extremely well in private equity. "As we become larger, we are looking to have larger and more direct stakes in property, infrastructure and private equity,” he noted.
PE fits well with large industry funds that have the internal resources to assess each deal and the ability to allocate to long-term illiquid assets. But increasingly, such investors also have other options, said Goss.
“For many investors, if they have a fee budget - and many in superannuation do - spending that budget on alternative risk premia [long/short strategies based on factors such as value, momentum and volatility] will bring more diversity to the fund rather than private equity, which still carries a lot of equity risk.”
RISK VERSUS REWARD
This attitude among Australian asset owners fits the trend identified by a survey released earlier this week which found that while investors are increasingly turning to alternative investments in search of higher returns, hitting performance targets will be a challenge.
Most of the investors in the survey who said they had reduced their allocation to PE said it was because asset valuations have become prohibitively high and the prospects for good returns were better elsewhere.
Goss noted that Australian funds with less constrained mandates and a specific investing objective could use PE "as the best way to play a theme such as renewable energy.”
Christian Super, with A$1.4 billion under management has gained a reputation as a leader in the responsible investment and impact investing area. Senior portfolio manager Edwin Lo told AsianInvestor the Sydney-based fund has used the private equity route to access high quality impact deals appropriate for its particular objectives.
Christian Super allocates over 10% of its fund to impact investments, and Lo said that proportion to expected to grow to 15% in the next three years.
“It [PE] allows for particular exposure to certain business, industry or jurisdictions, becoming a critical point for portfolio construction," he told AsianInvestor.
He added that while some asset owners in Australia are still keen on private equity, they are likely to become more demanding. “Investors will still be allocating to PE because it offers a highly diverse opportunity across multiple asset classes,” he said.
However, there is a lot of dry powder, and most prospective transactions or deals may not present meaningful upside in the short term, he added.
Lo also pointed to another shift taking place -- PE funds are targeting more co-investments, secondaries and direct investments when they design strategies. That is to avoid blind pool risk associated with some funds.”
A blind pool gathers money from investors, who then trust the general partners and managers of the pool to invest appropriately.
Apart from avoiding blind pools, they also enable a shortening of the J-curve effect, Lo added. In the first few years of a PE investment, upfront investment costs and management fees have a big impact on returns, and underperforming portfolios are often written off. If the fund is well managed, it will recover from its initial losses and the returns will form a J-curve.
“Another key factor of this co-investment approach is that it effectively reduces total fees charged to clients, which is quite topical, with RG97 coming into force very soon,” Lo added.
The Australian Securities and Investments Commission is introducing new fee disclosure rules from September 30 under Regulatory Guide 97 that will require super funds to detail the costs associated investments in private equity, unlisted property and infrastructure.