Historically, the world’s largest investors have dominated the private equity asset class. Australia’s Future Fund, for example, currently allocates approximately 15.1% to private equity, according to its January 2024 portfolio update [1].

Growth in private equity allocations reflects a 20-plus-year trend. In 1996, there were 8,090 listed United States companies, yet by early 2020 this had more than halved to 3,687, according to S&P Capital IQ data [2]. 

At the same time, the US plays host to 11,159 private companies. In Europe, there are 4,668 listed developed-market companies compared to 281,608 European private companies, according to data from S&P Capital IQ and the World Bank [2].  
 

Potential benefits of private equity

In Pengana’s view, investors could choose to allocate to private equity for potential long-term growth.. Diversification is also a factor to consider, due in Pengana's view to private equity’s low correlation [return relationship] with listed equities and bonds. 

Aside from a larger number of available investments, private equity has tended to deliver higher returns compared with listed equities. According to research prepared by Bain & Company, private equity delivered 14% per annum globally during the last 25 years versus 7% per annum for the MSCI World Index (listed equities) [3]. 
 

Different private equity investment strategies

Private equity strategies vary greatly. In Australia, investors tend to associate private equity investing purely with venture capital (VC), but this is only one small part of private equity. In Pengana's opinion many large global private equity managers have low exposure to VC due to what they perceive as its risks.

Most global private equity investment strategies use “buyouts” or “growth equity” when allocating to private companies, as the summary below explains:

• Buyouts are most common, through either acquiring or taking a controlling position in mature companies with established cash flows. Financial structuring and operating expertise are used to improve company financials and position the company for a strategic sale at higher valuation.
  
  
• Growth equity involves building companies with solid, proven business models, which are poised for further growth due to strong demand, good management, a good balance sheet, and a point of difference.

With corporate activity reduced over the last two years, private equity managers have targeted other strategies including:

• Secondary transactions involve acquiring an interest in a company via an existing investor/private equity manager, who is often selling because they are overweight to private equity. Secondary transitions provide opportunities for private equity managers to gain exposure to companies potentially at discount. 
  
  
• Private credit involves investing in loans provided to private companies. In Pengana's opinion this strategy has been in favour with private equity managers since central banks increased interest rates. Private credit can be high risk if linked to distressed companies. Pengana believes private credit is most effective when targeting good companies which need to address their balance sheet yet have a sound footing.

Risks with private equity

There are several risks to navigate, with liquidity risk at the forefront. [Liquidity risk is the ability to buy and sell securities in an asset quickly]

Private equity investments are specifically structured to be illiquid, and in Pengana's experience many private equity funds have a life of 10 years or more, although some investments may see some realisations after five to seven years. 

Managing liquidity and cashflow risk is why many private equity managers have exposure to hundreds of companies across different investment styles, sectors, industry, vintage year (the year the investment commenced), and exit strategies.

 A manager might invest in more than 500 companies, to spread the liquidity risk.Listed private equity funds may help address the liquidity issue, but there is a risk the listed private equity vehicle may trade at discount to its Net Asset Value (NAV) for periods. [Editor’s note: This means the listed private equity fund is theoretically worth less than the stated value of its assets].

Market risk can also be a factor. As with listed markets, investors don’t want to be over-exposed through private equity to certain sectors or industries that are struggling. 

Transparency with private equity is not the same as listed investments on exchanges. Investors need to work harder to understand the risk profile of their underlying private equity investments, the exposure to leverage [debt], and whether there is over-exposure to higher risk segments like venture capital. Investors can put a lot of faith in their private equity managers to invest “true-to-label”. 

Given that most private equity opportunities are global, investors also need to understand the currency risk and how currency fluctuations will impact returns.

Fees with private equity are often higher than listed strategies such as Exchange Traded Funds (ETFs), as global private equity investments go through specialist managers, and the most sought after managers have pricing power [an ability to charge higher fees].

Potential opportunities 

Pengana is most interested in private equity opportunities that are global – as in its opinion Australia’s economy doesn’t have the depth and breadth to compete with the opportunities on offer in the US and Europe. 

Pengana favours high-quality, growth-oriented middle-market companies in private equity. Mid-market companies are not small by Australian standards. These are companies with a market capitalisation between US$500 million – US$1.5 billion. There are approximately 89,000 companies in the middle market in North America and Europe, according to Pengana’s analysis.

A question of access

Access to global private equity has been challenging. New funds from many top-quartile performing private equity managers can be oversubscribed before they open for investment. 

In Pengana's experience, a usual minimum commitment is $5 million to $10 million during an initial fundraising period, which suggests that building a truly diversified private equity portfolio requires around $100 million in capital. Even then, there is no guarantee that investors can access top-quartile managers. 

As a result, most Australian investors have been effectively locked out from accessing global private equity due to this high barrier to entry. But things are changing.

There are other options now available, including listed private equity, which can allow investors to access a diversified PE portfolio with top-quartile managers via the liquidity of the ASX. It’s a considerable step towards democratising private equity for everyday retail investors, where it has previously been an asset class available to the big end of town.

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[1] January 2024 portfolio update

[2] Sources: S&P Capital IQ (utilising certain information obtained from its database) for public and private company data as of 2 January 2020. Includes all private companies with revenues ≥ US$15 million. The World Bank, https://data.worldbank.org/indicator/cm.mkt.ldom.no, for historical listed company data (31 December 1996 for the U.S.; 31 December 2001 for Europe). Neither S&P Capital IQ nor the World Bank has provided consent to the inclusion of references to their databases and publications or material drawn from the databases and publications.

[3] Bain & Company Why Private Equity Is Targeting Individual Investors