LP interview: HESTA

Among Australian LPs, Andrew Major can lay a strong claim to be the private equity industry’s best friend – or at least its highest-placed. Earlier this year he took over as chairperson of the Australian Investment Council (AIC), formerly the Australian Private Equity and Venture Capital Association, becoming the first member of the local institutional investor community to hold the role.

Stepping up to chair AIC was a logical step for Major, the general manager for unlisted assets at Health Employees Superannuation Trust Australia (HESTA). Since joining the superannuation fund in 2009, Major has worked to deepen its exposure to private equity and other private market investments, such as infrastructure and real estate, as well as build up the team’s understanding of how these classes influence each other. 

“When you’re talking to private equity managers about what they’re dealing with in their market, it’s often things that an infrastructure manager has dealt with or that we’ve seen in other asset classes,” Major says. “The distinction between investments is blurring – you almost need to look at any unlisted asset investment you make along a risk-return continuum, and not really define it by asset class.”

Expanding HESTA’s private market expertise remains a priority for Major as the group continues its shift toward a more active investment style, pursues co-investment opportunities, and increases commitments to managers outside Australia. As more capital enters PE globally, the superannuation wants to become a valuable partner to its GPs.

Direct engagement

HESTA’s private equity strategy began in the late 1990s, and like many of its peers the superannuation fund played it safe with a relatively passive approach dominated by fund-of-funds. Venture capital managers accounted for the largest share of the portfolio, followed by growth equity and buyout. 

By the time Major came on board, the fund had begun to outgrow this model. It was time to take  unlisted assets exposure to the next level by forging direct GP relationships with GPs. Over the following decade HESTA reoriented away from fund-of-funds and shed its VC commitments completely. An exception is continued exposure to a few early-stage life sciences managers such as LeapFrog Investments – retained to support healthcare advances that might benefit members.

Today, unlisted assets comprise 26.5% of HESTA’s global assets under management (AUM), which stood at A$46 billion ($32.8 billion) as of June 2018. Private equity accounts for 5% of AUM, while infrastructure and real estate stand at 12% and 9.5%, respectively. Global fund managers make up the lion’s share of the PE portfolio, but the LP does have exposure to Australian GPs and has also started to build relationships with Asia-focused managers such as Madison India and PAG Asia Capital.

Co-investment has become an increasingly useful tool for HESTA, particularly in developed markets. However, building the LP’s capacity in this area has been a challenge, particularly as HESTA likes to conduct its own due diligence rather than rely solely on a GP’s judgment. This strategy ideally requires input from an experienced private equity professional, but matching the compensation levels offered by GPs is difficult. Institutional investors must dig deeper to identify recruits that will fit with their goals.

“You want to find people who have had direct investment experience, but also understand that managing capital as a fiduciary like we do is about more than just putting it to work in transactions,” says Major. “We need people for whom compensation is important, but there are other reasons why they’d want to move to a place like HESTA.” 

Superannuation funds offer a number of attractions for deal makers who are looking to use their skills in a new context. For one, the structure of a group like HESTA means that employees can focus on investing rather than fundraising, and have more freedom to make commitments without needing to plan an exit within a fixed timeframe. 

Having worked at Macquarie before joining HESTA, Major is also aware of how a sense of purpose – in this case, providing a comfortable retirement for the superannuation fund’s members – can unite a team in a way that is not always possible when the primary focus is financial returns. Experience on the GP side has been useful in helping him spot potential team members whose motivations will help them mesh with the rest of the firm.

“We’re lucky to be in a situation where we have a small team, but one that has experience on the direct investment side, so they can interrogate models, assumptions, and business cases, and develop a decent insight in a relatively short period of time,” Major says. “But I think it comes down to the nature of the people you have, and we do what we do because of who we’ve got.”

This approach has worked well in developed markets, but limited headcount remains the biggest impediment to HESTA growing its exposure to unlisted assets. Developing markets are especially challenging. In these areas the superannuation fund relies more on advisors – for example, StepStone Group helps identify fund relationships in China – reasoning that trying to approach such a nuanced market directly would mean more risk than could be justified to members.

“It would be hard for us to try and build up our expertise and capability on our own in order to enter markets that could be perceived as riskier by people used to Western-style private equity,” Major says. “There is still a gap that you need to bridge in terms of how private equity is done in places like China and India. Having an advisor with people in country gives us a better visibility into the market and a better ability to make investment decisions there.”

Despite HESTA’s growing overseas reach, Australia remains an important investment destination. Its domestic managers include Allegro Funds and Pacific Equity Partners, in addition to membership of the superannuation fund consortium that controls IFM Investors. Major expects support for the community to grow as other superannuation funds build relationships with GPs.

However, the market also presents challenges. Most notably, while institutional investor appetite for private equity is growing, there are not enough domestic managers raising funds of sufficient scale to satisfy demand. This problem is likely to become even more pronounced as superannuation funds continue to expand and as government reforms encourage smaller funds to merge, resulting in even more capital going to the largest GPs and leaving little for other managers.

Putting capital to work outside Australia is also expected to be difficult in coming years as long as the surge of allocations to alternatives globally continues. Australian institutional investors will find themselves competing for positions in funds, and those with less experience might struggle. 

Times of plenty 

The glut of capital has also shifted the balance of power in private equity. With no shortage of capital, managers are confident enough to set terms for their funds and challenge investors to take it or leave it. “It’s like a pendulum that swings back and forth depending on the amount of capital in the market and the ease of raising money and putting it to work, and at the moment that pendulum has swung toward the GPs’ side,” says Major. “We’re seeing that in how quickly managers are looking to open a fund and close it, which in turn has truncated LPs’ ability to have a really good look and negotiate terms.”

This exuberance could also lead to more cavalier behavior by GPs, particularly around fund size. HESTA was recently approached by two of its GPs that had decided to raise twice as much money as in the previous vintage. The superannuation fund decided to back one vehicle, but for the other it felt the increase wasn’t warranted. There was no re-up.

As the market heats up, remaining disciplined in the face of GP pressure will be increasingly important for LPs. Investors must be willing to pass up opportunities that they are not comfortable with, even if it means missing out on a popular manager. Relationships are supposed to survive for 10 years, so the most important factor is ensuring from the beginning that it is built to last.

“There’s always pockets of money in private equity, in some part of the world or some strategy, so I don’t think we have the luxury of saying we’re not going to invest,” Major observes. “The question is where and how, and whether the managers we’re looking to work with are happy with a balanced partnership approach rather than trying to take more out of the next fundraise in terms of GP-friendly rights, or to raise a bigger fund just because they can.”   

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• Topics
• Australasia
• LPs
• Healthcare
• Infrastructure
• Fundraising
• Australia
• HESTA
• Co-investment
• India
• China