Future Fund: private equity is becoming less attractive

High prices for assets and a lack of differentiation among GP business models is making the asset class less appealing, according to the $106bn SWF's head of PE Steve Byrom.

High prices for assets and a lack of differentiation among GPs’ business models are making private equity less attractive, according to the head of the asset class at Australia’s A$148.8 billion ($105.6 billion; €92.6 billion) sovereign wealth fund.

“I’m concerned at the prices being paid for beta today, the cost of beta exposure and the ability to continue generating upside at the prices being paid,” Future Fund‘s Steve Byrom told Private Equity International in an interview at the investor’s Melbourne headquarters.

(c) Michael Kai Photography
Byrom: concerned at pricing paid for beta

The high cost of assets implies private equity is a “far more efficient market than it’s supposed to be”, Byrom said.

Private equity sponsors paid on average 14x EBITDA for US assets and 11x in Europe last year, according to data from S&P Global Market Intelligence, and 14.1x in Asia-Pacific, according to Bain & Co.

“At a big picture level, this asset class is becoming less attractive,” he said. “Business models aren’t sufficiently differentiated because of the number of GPs in the ecosystem and the amount of capital competing for a reasonably small number of bidders. Those kinds of competitive dynamics worry me.”

Future Fund’s private equity portfolio grew by 3 percentage points to 14.8 percent of its total portfolio compared with a year earlier, according to its latest quarterly update as of 30 September. The growth came amid a drop in its cash exposure to 14.4 percent from 18.9 percent, while debt securities also fell to 8.8 percent from 9.9 percent of its total portfolio.

“Inflationary pressures are gradually building in the US and markets continue to respond to rising interest rates,” Peter Costello, chair of the Future Fund Board of Guardians, noted in the update. “While the short-term economic outlook remains reasonably positive, we remain cautious about the longer term outlook, the impact of geopolitical and trade tensions and the potential for shocks to markets.”

China and secondaries

Future Fund is particularly excited about opportunities in the Chinese market where local GPs are becoming more sophisticated and are doing “more than just multiple arbitrage”, according to Byrom.

“We’re starting to see opportunities to put capital to work where we feel very comfortable with the GPs we’re working with,” he said. The fund counts Hong Kong-based Citic Capital and CDH Investments as well as Beijing-based Hillhouse Capital Group among its China-focused private equity managers, according to its website.

The fund has also been using secondaries to manage its private equity exposure. In 2016 Future Fund sold a portfolio worth around $1 billion to Canada Pension Plan Investment Board, as sister publication Secondaries Investor reported, and the sovereign investor would consider using the secondaries market again to rebalance its portfolio, Byrom said. Using secondaries is far better than scaling commitments up or down, he added.

“Some people seem to think that scaling commitments is a lever to pull to try to get the portfolio moving. It’s just far too slow moving to have an impact within three or four years.”

While some firms such as BlackRock and KKR have launched products like long-term funds to hold assets for longer, Future Fund is not the type of investor to commit to such strategies, Byrom said.

“There are pools of capital where that’s quite appropriate and it works, and there are other pools of capital where it doesn’t make sense to do,” he said. “We’d probably put ourselves in the latter camp.”

When it comes to how the SWF incorporates environmental, social and governance issues among GPs into its day-to-day portfolio management, Future Fund is particularly looking at social diversity, according to Byrom.

“Our hot topic would be diversity of thought, ie, a GP made up of classmates from, say, Princeton,” he said. “It’s not just gender, it’s also experiences and different ways of looking at things that they bring to the table – upbringing, education, background, different societal norms.”

Future Fund was established in 2006 to strengthen the Australian Government’s long-term financial position. It invests five funds: Future Fund, DisabilityCare Australia Fund, Medical Research Future Fund, Building Australia Fund and Education Investment Fund.