Few heads of private equity for a sovereign wealth fund would be comfortable learning their portfolio had shrunk by 17 percent in a single quarter; Future Fund’s Alicia Gregory is an exception.

The A$161 billion ($118 billion; €99 billion) institution offloaded around A$6 billion of private equity assets in the second quarter of 2020, acting chief investment officer Sue Brake told reporters on an interim results media call on 2 September.

The value of Future Fund’s private equity portfolio fell by A$5.1 billion to A$24.4 billion between 31 March and 30 June, the results said. Its exposure dropped 3 percentage points to 15.2 percent.

“Our PE allocation had increased due to the performance of the portfolio and because it’s Australian dollar-denominated,” Gregory tells Private Equity International. “We make a lot of our investments in offshore markets, and so as the currency moves, so does our position.”

Future Fund’s move wasn’t a knee-jerk reaction to the pandemic: the institution appointed secondaries advisor Greenhill as early as the second half of 2019 due to its hefty exposure at the tail-end of a 10-year bull market.

“You have no idea what’s coming but you want to make sure you’re positioned well for whatever comes, so we made the decision to lighten our private equity portfolio last year and create some more liquidity for the fund,” Gregory says.

“We never would have predicted a covid but if there is any dislocation or wobbles in the market, that liquidity is always the important thing to have up your sleeve. Better to be lucky than smart, as I told someone at the time.”

Future Fund’s cash position rose to 17 percent from 9.6 percent in Q2, per the interim results. In a statement at the time, chief executive Raphael Arndt said the sale would ensure the fund had the flexibility to respond to emerging opportunities and risk.

Staking a claim

Launched in 2006, Future Fund invests with the intention of bolstering Australia’s long-term financial position. The government has been permitted to withdraw from the fund since July 2020 but previously stated it would defer drawdowns until 2026-27.

Future Fund’s overall portfolio has generated a 7.5 percent return since inception against a 6.5 percent target, and 9.2 percent on a 10-year basis versus its 6.1 percent benchmark. It does not disclose the performance of individual asset classes.

Gregory, who is based in Future Fund’s Sydney office, joined in March last year following a 14-year stint at National Australia Bank’s investment arm, MLC, where she oversaw 40 co-investments and a A$5 billion private equity fund portfolio, according to her LinkedIn profile. She sits on the membership committee of the Institutional Limited Partners Association.

Alicia Gregory
Alicia Gregory: It’s never been more important for us to be really focused on making sure we can generate really strong risk-adjusted returns

Her appointment followed the departure in December 2018 of former private equity head Steve Byrom and two Future Fund directors, who together launched investment consultancy Potentum Partners.

She inherited a private equity portfolio that stood at A$25.7 billion, or 15.8 percent of the fund, as of 30 June 2019, of which 61 percent was invested in the US and 61 percent in venture and growth equity, per its 2018-19 annual report. It had relationships with 33 managers at the time, including the likes of Bain Capital, Hellman & Friedman and Advent International.

Gregory declines to comment on the composition, pricing and structure of what was sold this year, but tells PEI the decision was made following a bottom-up analysis of the portfolio. “A lot of people approached us about buying things in our portfolio,” she says.

“Long-term relationships are really important to us and I think everybody who is our investment partner understands the importance of that. But one thing most managers respond to is that at the right price, almost anything in your portfolio could be for sale.”

According to Future Fund’s interim results, the private equity sale reduced its exposure to international growth and buyout managers.

In July, sister title Secondaries Investor reported the sovereign wealth fund had sold more than $2 billion of private fund stakes, with Carlyle Group’s AlpInvest Partners accounting for the largest share and the remainder purchased by a mix of secondaries funds and non-traditional buyers. Pricing and terms were understood to have been decided before the pandemic hit.

A UK public filing dated 6 May noted Future Fund transferred a stake in 2016-vintage buyout fund Charterhouse Capital Partners X to vehicles linked to AlpInvest Secondaries Fund VI and AlpInvest Secondaries Fund VII.

“The combination of our desire to lighten the exposure, as well as analysing from the bottom-up what we think the forward looking returns for investments might look like and how the secondary market is pricing a lot of opportunities, was part of [deciding what to sell],” Gregory notes.

It’s unclear whether preferred equity was involved. Gregory declines to comment, but notes the fund received “a really vast arrangement” of approaches from people.

“It’s an interesting time in the secondary market as preferred equity becomes more prevalent,” she adds. “It was really interesting to see the different approaches people had.”

Technical prowess

Technology would play a crucial role in Future Fund’s liquidity and risk management during the pandemic, having built its own platform to provide real-time analysis of all holdings.

Private equity valuations are typically subject to a quarterly lag, a dynamic that has caused major headaches throughout the crisis. In March, for example, CFOs were mulling whether to adjust their soon-to-be-published 31 December valuations to reflect the rout in public markets.

“Managers value things generally quarterly [but] they don’t all show up on the same day, so you receive them over the quarter,” Gregory notes.

“In your private book there’s also some listed positions, so you can very quickly know where your listed positions are and how they’re moving. There are a number of managers that allow you to understand themes in your portfolio and if there are certain subsegments of the portfolio, such as your exposure to oil and gas.”

Investors have, to some extent, been at the mercy of GPs when it comes to understanding the impact of coronavirus on their portfolios. Approaches have been varied: one North Asian firm told PEI in March it would disclose updated portfolio company financials alongside its Q4 2019 reporting that month, while a South-East Asian firm said it had already distributed ad hoc financial details for its latest fund.

“As a bit of a generalisation, US managers were really overcommunicating during March and April and giving us real-time information,” Gregory says.

“In markets like Asia, managers were a little more hesitant to share information. There was some nervousness so I kept saying, ‘I know it’s not going to be 100 percent correct and it’s ok to give a range, but some guidance on where we’re going is very useful to us right now.’”

Opportunity knocks

Unlike many institutional investors, Future Fund invests with a whole-of-portfolio approach and is under no pressure to maintain its allocation to any one asset class.

“We’re not just looking at the types of assets we can get through other asset classes; there are things that are very similar to public equity but getting held in the private domain,” Gregory says. “We’re really looking for access to the types of opportunities we don’t see in other parts of the portfolio.”

Opportunities likely to catch Gregory’s eye include those looking to capture what she terms the “innovation cycle”. These can occur across the spectrum, from start-ups, to growth equity, to buyouts, but typically involve a technology or disruption angle.

“The dispersion of returns in private equity is very broad, so you need to be very focused on getting access to the best ideas,” she says. “Getting access to the innovation cycle is an important component of what we’re looking for in our portfolio – making sure we can do that at a reasonable price and making sure we’re getting paid for the risk and illiquidity we’re taking.”

Innovation has been accelerated by covid-19: e-commerce, video conferencing and online education are among the sectors experiencing major tailwinds as global economies pivot to remote working.

“Industries are changing quickly and much of that innovation is coming out of the private markets,” Gregory adds.

“If I think about online shopping, the penetration in Australia had still been quite low compared to other developed markets but it’s now increasing substantially because people can’t go out.”

Team effort

Many investors of Future Fund’s size have the means to invest directly and are handsomely rewarded for doing so. Alaska Permanent Fund, a US sovereign wealth fund, for example, has generated a 36.9 percent five-year net return on its direct investment portfolio, versus 18.4 percent for private equity funds.

Future Fund has a legislative requirement to invest with managers, limiting its participation in this area to co-investments; its private equity team is carefully constructed to make the most of these opportunities.

“What we do, which is a little bit different, is have one integrated team that do funds and co-investments, so most people in our team come from some kind of directs background,” Gregory says. “The rationale for that is we consider co-investing a great way to really get to know your managers well and a great form of due diligence on a manager.”

Future Fund’s team also has the capacity to co-underwrite co-investment deals. Doing so can benefit LP and GP alike: the former gets a head start on attractive dealflow, a deeper understanding of a GP’s deal process and expertise in a preferred sector, while the latter can share the burden of due diligence and potential broken deal costs.

The strategy is increasingly popular: Teacher Retirement System of Texas, for example, said last year it would pursue co-underwriting opportunities in lieu of syndicated deals as the latter had become commoditised.

“In this period where a lot of people have more recently come to co-investing, being a differentiated partner and really looking at what we can do to be useful to our partners is probably the approach we’ve taken,” Gregory notes.

Future Fund’s enthusiasm for co-investments plays a significant role in its relationships with GPs.

“Future Fund is seen as hard to crack into,” an Asia-based placement agent tells PEI on condition of anonymity. “They’re far more strategic and usually require a different type of approach. GPs would have to offer more than just being a blind-pool investor; it probably has to be a strategic relationship with opportunities for co-investments.”

Long-distance relationships

While building and maintaining GP relationships can prove a challenge during the pandemic, disruption to global travel has had a limited impact on Future Fund’s private equity activity.

“Most funds last 15 years – longer than most marriages,” Gregory says. “Our due diligence period is quite long-dated, so not being able to travel since March isn’t really impacting anything we’ve been doing because we’ve probably been working with them and spent time in their offices over the last 18 months.”

Nevertheless, the fund’s predilection for lengthy courting processes does not preclude it from committing to less established managers.

“Having a team of people that have worked well together, have good balance and an ability to have people questioning each other is really important to us – you can find earlier funds that bring some of those dynamics,” Gregory notes. “One of the things in earlier funds or younger funds is sometimes you can find alignment of interest to be very good, in terms of the hunger and the desire.”

That alignment of interest is top-of-mind for Gregory when evaluating a manager.

“There’s many elements of alignment that I like about our asset class, and economics is one element of that,” she says. “The average GP commitment to a fund is around 2 percent, but not all 2 percent commitments are created equal. For some, that represents quite a substantial part of their net worth, whereas for others it might not be very much at all.”

However, the discussion is not limited to fees.

“There are all sorts of things that might drive different behaviours,” Gregory notes.

“For a lot of firms, the ability to raise their next fund is important, which might create a conflict between long-term returns and the need to show realisations. But there’s always a debate with GPs about selling good companies a little bit early to get realisations, because if you’ve got a realised track record it’s easier to raise your next fund.”

Private equity fundraising has soared in recent years – the asset class gathered $2.3 trillion between 2017 and 2019, versus $2.1 trillion in the preceding four years, according to PEI data. Increased competition among LPs clamouring to access their preferred funds has presented GPs with more power at the negotiating table.

“The ability to raise capital is like a pendulum, there are times when it’s really easy and times when it’s really difficult,” Gregory says.

“We’re a good partner when maybe it’s a little bit harder and in return we really look to our partners to treat us fairly when it’s more in their favour. Conversations in February were definitely in the GPs’ favour but fundraising has slowed since March, so it’s probably somewhere in the middle right now.”

Home-field advantage

To call 2020 an eventful year for Australia would be an understatement; ash from a catastrophic bushfire season had barely cooled when the country entered lockdown.

Domestic investments accounted for just 4 percent of Future Fund’s A$25.7 billion private equity portfolio at 30 June 2019, and 20 percent of the overall portfolio. Its domestic GP relationships as of March 2020 included Archer Capital, which in June froze plans to raise a sixth flagship fund for a second time, Quadrant Private Equity and The Growth Fund.

Future Fund also has an Australian venture capital mandate with US consultant Greenspring Associates.

“We’ve been really excited to see the growth within the Australian venture capital market,” Gregory says. “We’ve seen that innovation and real winners come out of the Australian market.”

The institution’s enthusiasm for domestic venture capital comes as larger segments of the market become more congested. Private equity deal value climbed 18 percent to $12 billion in 2019 and the number of transactions fell 5 percent to 52, according to Bain & Co’s Asia-Pacific Private Equity Report 2020.

The Australian government has been proactive in supporting the domestic economy throughout the pandemic; key measures include the JobKeeper Payment scheme to support businesses significantly affected by coronavirus.

“While we have seen large scale job losses in some sectors of the economy, particularly in those B2C sectors like hospitality and tourism, it’s clear the government JobKeeper programme has played a very significant, very profound role in supporting business viability during the height of the pandemic,” Yasser El-Ansary, chief executive of industry body the Australian Investment Council told PEI in June.

Future Fund’s investment performance will therefore directly contribute to Australia’s recovery.

“I don’t think it’s ever been more important for us to be really focused on making sure we can generate really strong risk-adjusted returns,” Gregory notes. “Because the government are playing a really important role in the economy right now and we are really focused on making sure we’re doing our part.”