Adrian Herbert
January 21, 2016

Super investing will disappoint VCs

Super investing will disappoint VCs

Superannuation fund investment teams find it difficult to get exposure to Australian venture capital

Super funds will invest less in venture capital this year than has recently been anticipated but their investments in private equity will increase significantly.

Private Equity Media’s 2015 survey of Australian Institutional Investors’ Intentions in Private Equity and Venture Capital investing found 12 per cent of respondents were strongly interested in investing in venture capital over the 2015-16 financial year, up from six per cent the previous year. A year before, the survey had found almost no interest in venture capital.

Anticipation of a significant revival of investment in venture capital resulted from announcements late last year of intentions to invest $650 million in the sector over the next five years.

First State Super, NSW, announced plans to invest about $250 million “in the short term” after committing $120 million to Blackbird Ventures’ $200 million second fund.    

HOSTPLUS said it plans to invest $400 million in venture capital over the next five years. This followed HOSTPLUS committing to the Blackbird fund and to the Brandon Capital Partners-managed third Medical Research Commercialisation Fund.

While these commitments and future intentions have been welcomed by the venture capital sector, they represent very small proportions of the superannuation funds’ investment capital. First State has $53 billion in funds under management and HOSTPLUS $20 billion.

Both funds are expected to continue to grow strongly from compulsory superannuation contributions.

But the Private Equity Media survey found most other Australian institutional investors (mainly superannuation funds) are much less likely to invest in venture capital, at least in the short term.

Superannuation fund investment teams typically would like some exposure to Australian venture capital but find it difficult to achieve this. Challenges include lack of liquidity in the sector – venture funds typically have 10-12 year terms – and the small size of the funds – in Australia, a $200 million venture capital fund is very large but it is small in the scale of superannuation fund investing.

Lack of liquidity is a disincentive across all alternative investments and is primarily managed by limiting the volume of investment but the small scale of local venture funds is a bigger problem. They are simply too small for most superannuation funds to allocate to as most superannuation funds will not want their commitments to amount to any more than 25 per cent of any investment fund.

The survey shows that, on average, super funds with existing investments in the sector are allocating 5 per cent of funds under management to private equity and venture capital combined. So if an $80 billion fund wanted to invest half of that in local venture capital that would amount to $2 billion.

That sum would, of course, be invested over many years but the super fund would want to have relationships with a limited number of managers and make substantial commitments to funds.   The Australian venture capital sector is evolving toward more specialist funds – digital technologies, medical devices, early stage technologies, later stage commercialisation and so on.

This should improve the effectiveness of fund level investing but is likely to keep funds subscale for superannuation fund investment.

A solution could be the creation of a fund-of-funds which would invest in best-of-breed specialist venture capital funds. This could be set up by the federal government much along the lines of the now defunct Innovation Investment Fund program with the federal government matching investment raised from the private sector (including superannuation funds).

The costs of the fund could be minimised by placing its administration under the umbrella of the Future Fund Management Agency. 

The survey shows that super funds currently prefer most of their average five per cent allocations to be invested in private equity rather than venture capital and over recent years there has been a strong trend for that to be invested globally rather than locally. Allocating globally meets the need to make sizeable fund investments and provides wide diversification within the asset class.

But the survey indicates the trend to global private equity allocations may have peaked. While most survey respondents indicated their primary allocations would be to international private equity in 2015-16, as the previous year, there was resurgent interest in local private equity funds.

This recognises that leading Australian private equity funds have, over the last few years, provided some of the strongest returns globally and that allocating to global funds, which are mostly US-based, gives very limited exposure to Australian private equity.

Sixty-per cent of respondents said more than 50 per cent of their allocation to private equity and venture capital was invested with overseas managers, down from 78 per cent the previous year.

Twenty per cent said less than 25 per cent of their allocation was invested overseas, up from 5.5 per cent the previous year. 

Direct investing – where super funds make their own private equity investments – and co-investing – where they make their own investments in companies in which their fund managers are investing – were strategies of strong interest to half the respondents. The other half, however, had very little interest.

This polarisation is most likely explained by two factors; the high fees charged by private equity fund managers and the low levels of private equity and venture capital expertise in most super fund investment teams.

Some of the largest funds have decided to reduce their overall level of fees in the asset class by developing their own in-house investment programs. Others have concluded that developing in-house expertise for private equity and venture capital investing would require too large a commitment for a five per cent allocation and have decided to continue to focus on allocating to specialist fund managers and advisers or not to make further allocations to the sector.   

Most investors – 91 per cent – plan to retain their current long-term allocations to private equity and venture capital. A large majority – 71 per cent – plan to make new investments in the asset class over the current financial year. Only 18 per cent have decided against making new allocations to the asset class.

A majority of respondents – 72 per cent –  considered their current investments in private equity and venture capital offered value for money on a risk adjusted basis. This was in sharp contrast to a year earlier when opinion had been evenly split.  

This change of opinion most likely resulted from strong returns from private equity investments over recent years seen against the background of faltering listed markets in 2015.

But the survey confirmed private equity is still viewed less favourably by Australian institutional investors than their global peers. The global average allocation is 10 per cent of assets under management, double the local figure.

 

Adrian Herbert is managing editor of Private Equity Media. Additional authors of the survey report are David Brown, a former senior superannuation fund investment executive, and Simon Uzcilas, a venture capital fund manager. Private Equity Media sought to survey 34 Australian investment institutions known to have investment in private equity or venture capital. Of these, 11 participated in the survey.

The full survey, including consolidated data, can be purchased from Private Equity Media. The executive summary of the report is available at no charge.

Enquiries email: adrian.herbert@privateequitymedia.com.au    

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