A handful of adventurous superannuation funds in Australia are going against their investment DNA. Instead of seeking out large, illiquid investments into assets such as infrastructure, or easily understood equity portfolios, they are seeking small investments in early-stage start-up companies.
For most of the country’s pension funds, such investing stands at the very fringes of what they do. Start-ups are often flighty concepts, born from an entrepreneur’s wild imagination. Return rates are uncertain, as are investment timeframes. Often the goal of these companies is to list on a stock exchange or sell out to larger competitors within a few years. For asset owners focused on predictable long-term returns, that can be a headache.
There are other challenges too. In their early days, new companies often require careful guidance on how to expand quickly and sensibly, how to recruit and retain good staff, and how to stay on the right side of partners and regulators. This inexperience means the risks of backing them are higher too. Successful start-ups can enjoy a rapid rise to success, but when they fail it can be swift and brutal.
That risk has led most pension funds to play at the edges of venture capital – allocating a small amount to third-party private equity funds that tend to favour late-stage businesses.
But a few, including Hostplus and First State Super, are taking a different tack. They are proclaiming the benefits of embracing early-stage risk in order to foster innovation in Australia’s technology industry. “The passion and energy of these entrepreneurs is exciting. You get a real sense they are building something unique and changing the future face of business,” declared Sam Sicilia, chief investment officer of Hostplus.
And others are coming to play too, albeit via venture capital and private equity funds.
Figures released by the Australian Private Equity and Venture Capital Association (AVCAL) in November estimate Australia as having A$25.8 billion assets held by private locally based equity and venture capital managers, making it the sixth-largest country in the region.
Recent fundraising activity has been high, with 10 funds securing A$5.4 billion in the first 10 months of 2018, an aggregate capital figure not seen since 2008. A large amount of this money will have come from Australia’s super funds. Their desire for VC is on the rise.
Daniel Petre, founding partner at VC fund AirTree Ventures, notes super funds have only recently begun rediscovering an appetite for local venture capital.
“Many super funds were invested in the sector in the 1990s and then when the dotcom bubble burst a lot of them lost money,” he told AsianInvestor. “The asset class took a long time to recover and when funds did start to invest again they went to the VC markets in Silicon Valley that could offer volume and a good track record.”
Of late, however, the pension funds have begun looking more locally. Petre said local VC firms raised just A$100 million in funds in 2013; last year that figure reached A$2 billion: “[It] shows a significant shift in appetite for local investments and is a sign that the market is becoming more sophisticated.”
The increasing war chests have helped VC funds strike more investments. AVCAL estimates that 204 VC deals worth a combined A$1.5 billion were signed in the 18 months to end-June 2018 (see chart). Newmarch at First State Super believes venture capital has superannuation fund attention because higher quality and sophisticated start-up companies have become available.
Standout examples include a Series C round of A$60 million raised by SafetyCulture, the developer of a work health and safety app, in May; and $40 million in Series C funding by graphic design business Canva, which counts Sequoia Capital and Felicis Ventures as investors, in January 2018.
With its fundraising, Canva became the second Australian start-up to reach unicorn status – with a valuation of over $1 billion. The first unicorn was software company Atlassian, which is now listed on Nasdaq.
“In the past five years we have had local companies like Atlassian and Campaign Monitor do very well on the global stage,” said Newmarch. “Successes like these help to build momentum and an eco-system is created where other entrepreneurs are encouraged to come to market and venture capital funds from overseas start to take an interest.”
RETURN AND RISK
The availability of high-quality companies can ensure superior investment returns, another key draw for institutional investors. And Australian VC funds’ average internal rates of return have improved lately, mirroring the recent increase in commitments to them.
“Ten- and 15-year returns are around 2% for Australian VC funds, which is low by global standards, but over the past five years returns have been significantly higher,” noted Newmarch, quoting figures produced by Cambridge Associates.
AirTree’s Petre said his fund and other larger local players are posting IRRs of 20 to 40 times for the past two years. That said, these are theoretical returns, as the funds are still their five-year investment cycle and haven’t yet begun harvesting.
“We won’t see firm numbers until late next year when we expect the exit phase to kick off,” he said.
Yet while some of this new crop of start-ups may fly to new heights, others plummet.
In May a Melbourne start-up called Unlockd flagged its intention to launch an initial public offering to monetise its model of rewarding mobile phone users for watching ads.
The previous year it had raised A$30 million in Series B funding led by Malaysian telecommunications company Axiata Group and high-profile Australian businessmen, including Lachlan Murdoch and Radek Sali of Swisse Wellness.
Then Google got involved. In June the internet services giant threatened to withdraw services from Unlockd. The threat effectively destroyed Unlockd’s business model; within four weeks of announcing its IPO plans, it entered voluntary administration.
This article was adapted from a feature that originally appeared in AsianInvestor December 2018/January 2019 magazine.