Friday Letter: Australia's new horizons

Among fans of cricket, Australians are acknowledged to do well away from home. As the latest Ashes series between England and Australia commenced yesterday at the Lord’s ground in London, it was in the expectation that the visitors would stand a good chance of maintaining an unbeaten run at the venue stretching all the way back to 1934.  

Macquarie Funds Management, the A$1.6 billion ($1.2 billion; €1 billion) fund of funds arm of Australian financial services firm Macquarie Group, is hoping that a team it has assembled also performs creditably in foreign pastures. Earlier this month, it announced the launch of its first overseas-based operation with the hire of three professionals from Pacific Corporate Group to oversee a A$225 million California-based investment programme targeting opportunities in North America, Europe and Asia. One might be forgiven for thinking that, as far as the average head of an Australian superannuation fund is concerned, the world begins in Sydney and ends in Perth.

For Australian private equity investors – unlike the country’s globetrotting sporting teams – the world is a small place, and Macquarie-style overseas ventures are rare. A recent study of Australia’s superannuation funds by the University of New South Wales, sponsored by Swiss fund of funds manager Adveq, found an impressive 75 percent of respondents investing in private equity – and also that 74 percent of commitments made their way into domestic funds (US funds accounted for 16 percent and the rest of the world just 10 percent). One might be forgiven for thinking that, as far as the average head of an Australian superannuation fund is concerned, the world begins in Sydney and ends in Perth.       

There are a number of good reasons for this apparent parochialism. One is that private equity in Australia is relatively young, and it is natural that limited partners taking their first steps into the asset class will initially do so where they can derive maximum comfort, which is likely to be on home soil. Secondly, according to market participants, LP agreements appear to be on average more favourable to investors than in the US or Europe, with fees generally lower and a greater ability to remove under-performing managers. Generous tax incentives are also on offer for Australian organisations investing domestically.

But while factors such as these help oil the wheels, performance is the ultimate determinant of a market’s attractiveness – and here the evidence seems impressive. Given GDP growth of between 2.5 percent and 4 percent over the last five years, funds have operated in a strong macro-economic environment. In addition, a bullish stock market has been a welcome recipient of new issues (and sponsors have benefited from the absence of restrictions on the amount of shares they are allowed to sell into an IPO). Anecdotally, it is also mentioned in despatches that corporates have been slow to understand the private equity model and have unwittingly handed them some inviting buying opportunities.

In a nutshell, Australian investors have simply had little need to look overseas with everything so rosy in their own back garden. Until now, that is. At the larger end of the market, competition is beginning to increase. While decent assets undoubtedly attract less of a scramble than in the US or in leading European private equity markets, the creep of the auction process is being noted with alarm. Pan-Asian funds, capable of mobilising ever-larger pools of capital in a favourable fundraising environment, see Australia as a prime target for the deployment of that capital. For example, JP Morgan Partners Asia , which is currently raising a $1 billion-plus fund, recently signalled to PEO its intention to launch a new office in Melbourne. Others are expected to reach the same conclusion regarding the desirability of an on-the-ground presence in the country.

In addition, the economy cannot be relied upon to maintain its momentum indefinitely. Warning signs in the form of high levels of debt, a slowdown in consumer spending and the prospect of a rise in interest rates are currently flashing. All of which tempts speculation about how management teams used to exploiting the good times will cope when confronted (perhaps for the first time) with a sustained downturn.

Perhaps most important of all, there is the issue of scale. With the total size of Australian superannuation funds growing rapidly (currently over $US500 billion and forecast to reach US$1.7 trillion by 2015, according to government figures), they are beginning to recognise that additional funds cannot be channelled relentlessly into the domestic market without being accompanied by a deleterious effect on returns at some point.

The Adveq survey referred to earlier found that the institutions canvassed anticipated reducing their allocation to Australia from 74 percent to 65 percent over the next two to five years, while increasing allocations to the US, Europe and Asia. Australian investors, it seems, are broadening their horizons.