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Private equity – A role for KiwiSaver?

In the first part of a two-part series Pathfinder Asset Management director John Berry explores where private equity should fit into KiwiSaver.

Tuesday, April 7th 2015, 2:00PM

by John Berry

Private equity involves investment in unlisted companies.  These generally require long time horizons and are perceived as delivering high returns.  It sounds perfect for KiwiSaver, yet there are few examples of KiwiSaver schemes embracing private equity investment.  This month we look at the private equity market in New Zealand and opportunities to invest.  In Part 2 next month we will focus on growth KiwiSavers and whether they should (or actually do) include private equity as an alternative investment. 

Private equity covers a range of unlisted share transactions such as expansion capital, leveraged buy outs and “special situations” (which can include pre-IPO funding or investing in distressed companies).  According to the New Zealand Private Equity and Venture Capital Association there were 42 private equity transactions in NZ between 2011 to 2013 with a combined value around $1 billion (average size $24m).   To put this in perspective, this is almost exactly half the value of IPOs floated on NZX over the same period (excluding the government’s mixed ownership model floats).  Private equity makes a significant contribution to capital raising in NZ.

Private equity (PE) and risk

Private equity investing is seen as high risk.  There are several reasons for this:

  • PE investments are unlisted companies, so there is uncertainty about when investors can exit and (prior to exit) what an investment is really worth.
  • PE target companies can be risky - often smaller than listed companies, employing high levels of leverage and involving either high growth or industry consolidation. 
  • Private equity investment does not involve public offer documents so has fewer investor protections.

These risks mean individual investments can fail.  There have been a number of high profile PE failures in NZ including Yellow Pages, Metropolitan Glass, Whitcoulls, Mediaworks and Blue Star.  Interestingly these large failures involved offshore PE managers, not NZ based managers.

A 2012 study by the New Zealand Venture Investment Fund found that 30% of 92 realised private equity transactions did not repay the initial investment in full. Knowing only 70% of investments will pay back your capital means there is high risk - but it comes with potential for higher returns.  This is the attraction of private equity.

Private equity (PE) and returns

Calculating PE returns is more complicated than for a bank deposit or conventional managed fund.   This is because PE funds call investor money in instalments (to match investments made) and periodically return capital (as investments are sold). For this reason the return metric used is the “internal rate of return” or “IRR” - this is the discount rate needed to make the net present value of investment cashflows equal zero (and so easily accounts for money flowing in and out of a PE fund). 

There is no single public source of return information for private equity funds in New Zealand.   Available return information comes with caveats – firstly some is not current and secondly returns are often quoted before any fees.  Returns (IRRs) from various NZ private equity funds (without disclosing names) are 28%, 30%, 31% and 50%.

These are juicy returns.  One manager targeting a 30% p.a. return explains this means your capital back plus distributions of between 2-3 times your capital (depending on the time frame). This is consistent with the New Zealand Venture Investment Fund study of 92 realised private equity investments which found an average return of 33.7% per annum.

But not all PE funds produce knock out returns.  One manager discloses IRRs of 7.6% and 11% in its 2 funds.  This level of return is not a disaster for investors yet does not truly reflect the higher risk from including private equity in your portfolio.

Is private equity a good thing?

From an investor perspective a small amount of private equity provides diversification. It can also bring high growth returns, so is well suited to an aggressive portfolio. 

From a “New Zealand Inc” perspective private equity can be a great thing.  Firstly PE funds are incubators for future IPOs.  This helps develop our capital markets.  Secondly PE funds can provide expansion capital to companies that are not yet large enough (or ready) to float.  They channel money into high growth SMEs which creates jobs and leads innovation. 

Many local PE managers focus on companies with a value up to $30m, with few looking at $100m or more.  Offshore PE players are looking for large targets in NZ – Quadrant for example seeks companies valued at $150m to $500m. 

Who are the PE managers in NZ?

There are a number of Australian and North American private equity managers that have been active in NZ such as Pacific Equity Partners, Archer Capital, Crescent Capital and Quadrant Private Equity.  There are thought to be 15 locally based managers – though none are household names.  These local managers include:

Private Equity manager Founded Number of funds or LPs (past and present) Total FUM raised # companies invested in (past and present)
Maui Capital 2008 2 $500m 8
Pencarrow 1993 4 $300m 30+
Direct Capital 1994 7 $800m 68
Knox Investment Partners 2005 4 $175m+ 15+
Pioneer Capital 2005 3 $275m 14
Waterman Capital 2004 2 $125m+ 10
Pohutukawa (note: also included in Direct Capital’s numbers) 2008 2 $135m 19
Movac 2004 3 $60m+ 23

PE funds are difficult for NZ investors to access.  They will typically not have public offer documents and so accept only sophisticated investors.  Their minimum investment may be $100,000, $250,000 or more. 

But there are some limited exceptions.  The two Pohutukawa Funds were launched with public offer documents.  Pohutukawa 1 started in 2004 with about 1,750 investors (average investment $30,000) and Pohutukawa 2 in 2009 with about 1,850 investors (average investment $44,500). The manager is a joint venture between Craigs and Direct Capital. 

Another possible exception is the Punakaiki Fund which failed to raise its target $20m in a 2013 public float as a listed vehicle.  It later launched privately and has disclosed a $4.6m fund value invested across 8+ companies.  It is now considering a public offer through a crowd funding platform (allowing it to raise up to $2m from “retail” investors without the need for formal offer documents).

Who invests in PE?

A typical private equity cycle is 7 to 10 years.  It can be longer - Pohutukawa 1 for example launched 11 years ago has so far realized only 8 of its 12 investments.

PE investing suits investors with a long time horizon and a need for a diversified portfolio, such as pension funds.  NZ investors include both ACC and the NZ Super Fund.  The Super Fund invested $30m with Waterman Capital (2010), $30m with Pencarrow (2011) and $40m with Pioneer Capital (2013).  High net worth investors also often have an allocation to private equity funds.

As a high returning but illiquid part of a portfolio, private equity has its place.  But it is a small place – the NZ Super Fund for example has only 3% in PE investments.

Concluding thoughts

In short, private equity can be a good thing for growth seeking investors, although it comes with a high level of risk.  Time frames can be long and prior to exit asset valuations can be uncertain.  But there is plenty of private equity expertise in NZ.  Can we make this high returning alternative asset fit into growth KiwiSavers?  We tackle that question next month.

John Berry, Director
Pathfinder Asset Management Limited

Seek advice:  Pathfinder is a fund manager and does not give financial advice.  Seek professional investment and tax advice before making investment decisions.

Tags: KiwiSaver Pathfinder Asset Management Private equity

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