Glum Down Under

Times are tough for Australian GPs, with limited partners’ enthusiasm for the asset class seemingly in decline – and competition from emerging markets growing

‘No worries’ might be the informal motto in Australia, but not within its private equity industry.

Considered by many to be the old guard of Asian-Pacific private equity, the challenges now facing market participants Down Under include a dulled domestic consumer sector, uncertain taxation policies and a waning interest in the asset class among domestic limited partners.

Add to that an unyielding Australian dollar, which is causing valuations to skyrocket, and cutting returns on investments, and it becomes apparent why any Australian fund managers in the market for a new fund are currently fighting an uphill battle.

Only the “rock stars of the industry” have been able to raise money, Peter Wiggs, managing partner of Sydney-based Archer Capital, recently told Reuters. One such example was Quadrant Private Equity, which closed its sixth fund closed on A$750 million in December last year after only being in the market for two months. Unfortunately, not everyone has managed to get the same sort of traction.

SHIFTING APPETITES

The Australian private equity industry has historically relied on domestic limited partners. But that may be changing – by necessity.

Recently, some Australian LPs, like the A$34.7 billion (€25.6 billion; $37.3 billion) Victoria Funds Management Corporation (VFMC) and A$25.4 billion Unisuper, have both ceased making new commitments to private equity in favour of other asset classes.

“We’re disappointed, having generated good returns for them, but they have decided holistically that it would be best for them,” says Su-Ming Wong, managing director at CHAMP Ventures. Unisuper had supported CHAMP Ventures in CHAMP Ventures Investment Trust 6, while VFMC was a sponsor in the firm’s debut fund, according to PEI’s sister data provider PE Connect.

In April, industry sources predicted that more domestic LPs would follow in their retreating footsteps in the coming months, due to a rising backlash against the perceived high fees associated with private equity, and changing investment attitudes.

“There’s been a shift toward a preference for more liquid portfolios on the part of pension fund members. If you look at pre-global financial crisis and post-global financial crisis, a lot more members have opted [to keep] their funds in cash, and if you get a lot of member preference for cash, you get less scope for managing illiquidity,” Principle Advisory founder Les Fallick told PEI.

One reason why many clients of Australian super-funds may be losing appetite for private equity may be the method these funds use to tally their private equity fees and results. They report fees through management expense ratio (MER) – the ratio of actual fees paid to net asset value.

However, that can be a problem with relatively young programmes, Jake Burgess, partner at Australian fund of funds Quay Partners, told PEI: “Most of these funds that have commitments to emerging programmes are not fully mature; very few of them will be cash flow positive. When you pay fees on commitments as you do in private equity and the investments take three or four years to ramp up, you end up with quite a high headline fee rate, and not a whole lot of denominator i.e. the net asset value.”

STAYING THE COURSE

One Australian LP that has no plans to give up its private equity programme is the A$122 billion MLC, the wealth management division of the National Australia Bank. It has about A$4.5 billion committed to private equity funds globally.

Alicia Gregory, portfolio manager at the super-fund’s private equity unit, says one reason why MLC continues to maintain its appetite for the asset class is because private equity has been consistently delivering good returns for her organisation. She suggests that one key differentiator between MLC and its peers may be the way that MLC administers its private equity programme.

“We’ve managed well to our asset allocation targets [despite] the movement of public market indices. We have diversity via region and strategy; this is something we do to reduce the risk that you get by running a more concentrated programme of managers,” she notes.

But as other domestic investors pare down their relationships and reduce allocations to the asset class, the likelihood is that the size of Australian funds raised – not to mention their LP bases – could change.

“Australian managers have typically had a significant portion of their funding base come out of the Australian market, and as those LPs disappear, they either need to find new LPs or they are going to have to reduce their fund size,” says Gregory. “I think that GPs have had the luxury of being able to raise their funds out of the Australian market in the past, and [that] is probably not going to be easy going forward.”

FILLING THE GAP

Domestic fund managers may look to fund of funds and international investors to fill out their LP bases. But due to the range of issues facing Australia’s private equity industry, garnering commitments could prove to be a challenge – even from overseas LPs.

“When polled, LPs generally don’t rank Australia as one of their top three priorities for the next 12 months,” says Enrique Cuan, co-managing partner at placement firm Mercury Capital Advisors. “Though the market provides unique and interesting opportunities, it lacks the sizzle that markets like China, India, Indonesia and even Korea offer.”

Competition with other emerging markets is a key factor, agrees Wong. Her firm CHAMP Ventures recently held a first close for its seventh fund, which is targeting A$450 million.

“Fund of funds are more focused on China and India; we have to convince them the risk-rewards in Australia are different,” says Wong. “We have to convince them to invest in Australia with a different psychological mindset.” It sounds like they might take some convincing.