Australian allocation shifts

Australia’s A$34.7 billion (€25.6 billion; $37.3 billion) Victoria Funds Management Corporation (VFMC), which is backed by the government and also invests on behalf of the Victorian public sector, recently decided to stop making new commitments to private equity. VFMC had amassed A$1.2 billion in private equity assets but had recently found itself overexposed to the asset class and decided to halt the programme in favour of making infrastructure investments instead.

One market source said in April that the change in direction was “sudden”, while local Australian trade magazine Investment and Technology reported just six weeks before the news broke that the co-heads of the LP’s private equity unit had been meeting with general partners overseas, believing they had board approval for up to A$150 million in fund commitments over the next three years.

But to some local industry players, the development came as no surprise. “Allocations to private equity by large pension funds are decreasing, in some cases pension funds are looking to get out of the asset class either permanently or at least the next four or five years,” says Les Fallick, founder and chairman of Sydney-based placement and consulting firm Principle Advisory.

There’s been a shift toward a preference of more liquid portfolios, on the part of pension fund members

Les Fallick

He pointed to Australian superannuation fund Unisuper, which in early 2010 set a precedent by scaling back its own commitments to private equity.

“There’s been a shift toward a preference of 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,” Fallick says.

Recent airplay of the dismal returns generated by the IPOs of TPG-backed Myer Group and Quadrant and Goldman Sachs JBWere-backed Kathmandu in late 2009 coupled with a number of retailers going bankrupt that were private equity-backed may have helped make investors more sceptical of private equity, notes Jake Burgess, partner at Australian fund of funds Quay Partners.

But he says the bigger issue at play may be the way in which private equity fees and results are tallied by Australian superfunds.

“The way Australian superfunds report fees to their investor base is through management expense ratio (MER) – the ratio of actual fees paid [to] net asset value,” Burgess explains. “Most of these funds which 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 which is the net asset value.”

This, he continues, has made fees pertaining to private equity seem disproportionately larger when compared to other asset classes in Australian LPs’ portfolios.

“It’s very difficult for anyone to champion a particular asset class because, with few exceptions, you can’t point to a particularly outstanding performance at the moment,” Burgess adds.
Principle Advisory’s Fallick agrees, noting that there was an “overemphasis in Australia on management expense ratio, as a matrix for comparing superfunds”.

“Because we are accumulation-style funds for the most part, the funds are competing on MER, so they are competing on the cost of their input rather than the net effect of the portfolio, and where you have comparison of pension funds on the basis of management expense ratio, then PE is at a disadvantage because it’s got a high management expense ratio,” Fallick said.

This would not be such an issue if private equity had continued to “massively outperform” all other asset classes in an LP portfolio, but for “right now illiquidity and fees issues only exacerbate any question marks over the performance”, says Fallick, who warns that more such developments are likely imminent.

“My opinion is that the VFMC and Unisuper cases are not unique, and we are likely to see a continuation of this trend.”