Diversifying with alternatives: How retail investors access private equity
Private equity is playing an increasingly mainstream role in financial markets as investors look for diversification away from highly priced public markets. As demand grows retail investors are likely to see more opportunities to participate in a market that has previously been closed to them.
When shares of US electric vehicle maker Rivian made a spectacular debut on US listed equity markets in the second week of November, it was a big payday for a group of Australian retail investors who had backed the company through private equity.
Innovative vehicles have provided a rare opportunity for Australian retail investors to play in the private equity universe that is usually the domain of large superannuation, HNWIs and sovereign wealth funds that are able to allocate vast sums of money for long terms to maximise returns.
The very nature of private equity – large investment sizes, long return horizons and illiquidity – has made private equity a difficult investment class for the retail market to access. Yet those same qualities are now in growing demand as investors survey an investment landscape of elevated asset prices, rising inflation, interest rate risk and market volatility for opportunities to diversify.
In a recent article, Deloitte highlighted the role of private equity becoming ever more important in the pandemic by providing capital and expertise to help investors weather the crisis better. Deloitte found demand for private equity funds is increasing as high returns and perceived low volatility continues to drive inflows from existing and new institutional investors. In 2020, 66% of institutional investors invested in private equity, up from 57% in 20161.
Unique in Australia, through the Pengana Private Equity Trust (ASX: PE1) launched in 2019, Australian investors have been plugged into a portfolio of as many as 350 unlisted global companies, including Rivian, backed by manager Grosvenor Capital Management. After a relatively short investment term for private equity, PE1 halved its holding by selling into the Rivian IPO and banked a three-fold return from its co-investment, according to Pengana Managing Director Russell Pillemer.
More than just tech stocks
Private equity is sometimes mischaracterised as early stage or venture capital funding of the likes that produced Google, Facebook and Uber. While such investments are there, it is a much broader universe. It covers any non-publicly listed companies or assets across any industry sector, providing a much wider range of opportunities for investors. Typically, private equity investors buy such companies and attempt to grow them over several years before selling them to other investors in public or private markets.
According to S&P Capital IQ figures, cited by Pengana, the listed universe accounts for just two per cent of investible companies with a turnover of more than US$15 million. What is more, the number of stock exchange-listed companies has, at least in the Northern Hemisphere, been falling for the past 25 years due to the increasingly onerous cost of compliance and reporting to public investors. From 1996 to 2019 the number of publicly listed companies in the US fell from 8090 to 3687, leaving 111,159 private companies. In Europe, the number has fallen from 6739 to 4668, leaving 281,608 private companies, data from S&P and the World Bank, quoted by Pengana, shows.
US markets opening to retail investors
US retail investors have long had access to private equity in the form of publicly traded managers such as Blackstone and KKR, which listed in 2007 and 2010 respectively. Exchange Traded Funds (ETFs) offered by managers such as iShares and ProShares also invest in the shares of publicly traded private equity investors.
The Australian Investment Council (AIC), which represents the private markets industry in Australia – including private equity, venture capital and private real estate, debt and infrastructure - says private equity remains the biggest and fastest-growing sector in the local market. Of the $209 billion managed by the nation’s biggest super fund, AustralianSuper, 16.5% or $32 billion, was allocated to private equity in 2020, according to the AIC Yearbook2. Some of the smaller mega funds have even more, with QSuper, SunSuper and Aware Super allocating more than 22 per cent of funds to private equity.
Private equity investors are also playing an increasingly significant role in investment markets. Ernst and Young reported this month that private equity firms accounted for 30 per cent of the global mergers and acquisitions activity in the first nine months of 2021, surpassing the previous peak of 25 per cent in 20063. With US$868 billion of deals already, the PE industry looks set for its first trillion-dollar year.
Seeing the increasingly mainstream role of private equity, an advisory group for the Securities and Exchange Commission (SEC) recommended in September that it be easier for retail investors to access private funds4. The recommendation came alongside a call from SEC Chairman Gary Gensler to reform fee, expense and performance disclosures in the US$4.2 trillion industry.
Pengana, VanEck tap local interest
Exchange Traded Product manager VanEck is set to tap the growing local investor demand for private equity with the launch of its own private equity ETF. The VanEck Global Listed Private Equity ETF (ASX:GPEQ) tracks the LPX50 Index that includes the largest and most liquid 50 listed private equity companies in the world with exposure to venture, growth and buy-out opportunities.
Rather than a direct investment in investee private equity companies, GPEQ will hold shares of companies that manage private equity investments, manage private equity funds or the funds themselves. The last sector is expected to be the smallest part of the GPEQ offering, although investors will still be tapped into as many as 3300 companies and 350 funds, according to VanEck Head of Investments and Capital Markets, Russel Chesler.
“We believe demand, toppy valuations elsewhere, and the uncertain environment bodes well for private equity,” Chesler says.
GPEQ’s approach sets it apart from PE1, which has invested around A$300 million with Grosvenor to gain access to primary, secondary and co-investments in companies managed by the US PE fund. Pillemer says that, as well as Rivian, Pengana’s fund has stakes in commercial space travel pioneer SpaceX, Brazilian cross-border payments fintech UBank and payments company Instacart. The Rivian trade came through the opportunity for PE1 to co-invest in a funding round alongside established PE investors.
“Access to deals is everything in private equity,” says Pillemer. “The top managers perform year in year out, and they are shown the best deals.”
Superior local returns for PE investors
For the time being, Australian retail investors won’t have an opportunity to invest in local private equity directly. Blue Sky Alternative Investments, which managed a mixture of private equity and private real estate funds, was torpedoed by short sellers amid concerns about fee and valuation disclosures and was delisted in 2020.
Investor demand has only increased since. According to AIC’s yearbook, Australian private equity firms raised $4.3 billion in 2020, which was 2.4 times the amount for 2019, and more than half the $8.3 billion raised by private capital firms for the year.
AIC puts the surge in raisings down to strong stewardship of the economy and government financial support for business through the first wave of COVID-19 lockdowns, as well as the returns on offer. Figures from alternative asset data services company Preqin, cited in the AIC 2021 yearbook, show Australian private equity funds from the 2011-2018 vintages offered returns of 13.3%, the second highest in the world behind the 13.5% for Asian funds5.
Whoever can crack the formula to bring those opportunities and returns to the local retail market is sure to find plenty of interest from investors eager to diversify.
1 Private Equity Firms Position for Post-Pandemic Growth. Wall Street Journal, February 22, 2021 https://deloitte.wsj.com/articles/private-equity-firms-position-for-post-pandemic-growth-01614024010
2Australian Private Capital Market Overview, Page 44: https://aic.co/common/Uploaded%20files/Yearbooks/Preqin-Markets-in-Focus-Alternative-Assets-in-Australia%20-%20FINAL%20Report.pdf?utm_source=website&utm_medium=cta&utm_campaign=AIC-Yearbook-2021
3 Witts, Pete, EY PE Pulse, November 4, 2021. https://www.ey.com/en_gl/private-equity/pulse
4 Securities Exchange Commission, Final Recommendations and Report of the Private Investments Subcommittee. https://www.sec.gov/files/final-recommendations-and-report-private-investments-subcommittee-092721.pdf
5 AIC Yearbook, Page 7: https://aic.co/common/Uploaded%20files/Yearbooks/Preqin-Markets-in-Focus-Alternative-Assets-in-Australia%20-%20FINAL%20Report.pdf?utm_source=website&utm_medium=cta&utm_campaign=AIC-Yearbook-2021