19 March 2019

New investor credo: in private equity we trust

Image credit: Jane Dempster/The Australian

(David Rogers, The Australian)

Russel Pillemer has been blown away by the level of investor interest in the Pengana Private Equity Trust initial public offer.

In two weeks it passed the $100 million minimum and could well reach its $600m maximum by the time the offer closes on April 10th.

“I’ve never seen interest for any financial product like this one,” Pengana’s CEO and co-founder told The Australian.

He says it’s “an absolute game changer” for Australian retail investors because they will finally have access to the elevated returns typically generated by global private equity, historically only available to the likes of sovereign wealth funds like the Future Fund.

And, by partnering with Grosvenor Capital Management to invest in and co-invest alongside private equity funds of about $US1 billion ($1.4bn) in size, Pengana won’t face the sort of high valuations and competition for assets faced by the biggest private equity funds.

“The asset class makes sense, the asset manager is solid and it’s a space where there’s nothing else available,” Pillemer said.

“If you look at all companies in the US and Europe with revenues in excess of $US50m per annum, the percentage that is listed is only 6 per cent.

“If your investment universe is limited to listed investment companies you’re effectively ignoring 94 per cent of the investment opportunities in the world. The unlisted space is much larger than the listed space.”

He pointed to the US market, where in the year 2000 there were approximately 9000 listed companies but 19 years later there are just 4000: “The listed markets are shrinking at a dramatic rate. If you’re a $1bn or $2bn company in the US it no longer makes sense to be listed. It’s too costly.

“Quarterly reporting is a horrible way to operate. If you miss expectations for quarterly earnings your stock gets punished. Companies should be making investment decisions for the long term, not for the next quarter.”

Whereas on the Australian sharemarket $1bn-$2bn companies are mainstays, in the US that part of the market is shrinking rapidly as companies find it more efficient to stay private, but they still have demands for capital.

“They still have shareholders who may want to sell, they might want to buy companies or grow their business, so they are still capital hungry, but they just raise their capital outside of the listed markets,” Pillemer said.

“Private equity has moved into fill this void.”

The private equity world has grown in leaps and bounds since 2000, when there was $US600bn invested, to in excess of $US3.5 trillion now. And it has outperformed listed equity by about 5 per cent per annum in that time.

“That’s because it’s easier to manage companies for the long term and private equity doesn’t necessarily have to pay the highest price to make the investment, since its ability to add value can be taken into consideration. If you’re a great private equity group you’ve got lots of investment opportunities and you can probably buy them at a reasonable price,” Pillemer said.

For the medium-sized private equity firms it’s not about ripping out costs and boosting leverage to turn around a company for IPO.

“Operational improvements can give significant upside without needing to use massive amounts of debt,” Pillemer said.

He said Australian investors otherwise had limited access or ability to find private equity managers and most were closed to new investors: “Even if they would take your money the minimum investment you would have to make is probably at least $10m.”

Pengana has solved that problem by partnering with Grosvenor, one of the biggest and most diversified independent alternative fund managers. Its parent, GCM Grosvenor has $US52bn in assets under management, relationships with hundreds of private equity managers and a track record spanning two decades. And it focuses on the medium-sized managers Pengana is after.

A second problem faced by retail investors wanting private equity exposure is its inherent lack of liquidity.

“Most investors we have, even wealthy investors, don’t want to be tied up for 15 years. Our trust is exactly the same as a listed property trust or listed infrastructure trust except instead of the underlying asset being property or infrastructure, our underlying asset is private equity,” Pillemer said.

He noted that for the $US3.5 trillion of private equity in the world, the sophisticated institutions — like billionaire family offices or sovereign wealth funds — tended to have about 25 to 30 per cent of their portfolios held in private equity.

But, because of the lack of access and liquidity, it’s extremely unlikely that retail investors would have it in their portfolio.

“Everyone loves private equity because of the high returns and low correlation with listed equities, the question is about access and liquidity. Everyone we speak to wants it as part of their portfolio and for the first time we can show them how,” he said.

But Pillemer also envisaged the Pengana Private Equity Trust being a very defensive part of people’s portfolios.

“Yes, private equity has generated great returns historically but we also see this has great defensive attributes,” he says.

“First, there will be a 4 per cent yield per annum with 2 per cent paid every six months. Second, the valuations of these businesses are quite ‘sticky’ so they shouldn’t fall as much as listed equities in a down market.

“Third, the assets are in US dollars and we are unhedged. So if markets fall over you should gain on the currency, but should be quite good on the valuation."

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