Future Fund stresses risk-reward balance in private market strategies

LPs that have more capital to invest but fewer attractive opportunities to invest in are naturally drawn to the potentially higher returns of private markets, Wendy Norris told the Australian Investment Council’s (AIC) annual forum. However, they must pay a premium – in the form of higher fees – for the skills to navigate the complexity of PE, and illiquidity can present a challenge.

“You end up with a less flexible portfolio and you might not be able to meet the demands of your beneficiaries,” Norris said.

To a certain extent, they have little choice but to participate. The shift in focus from public to private markets reflects an immediate need for returns in a low-interest rate and subdued inflation environment and a response to fundamental change in where alpha is being created. Future Fund is no exception. Private markets accounted for 45% of its A$147 billion ($103 billion) portfolio at the end of last year, with 16% in private equity.

These dynamics have helped GPs raise larger funds, which is not necessarily a positive outcome. “In private equity, we see fund managers awash with capital and struggling to deliver the same returns they delivered in the past,” Norris noted. “It used to be you could buy a company, add leverage and sell at a profit in a few years’ time. Now, you have to take every opportunity to add value at every stage of the lifecycle of an investment.”

Future Fund has exposure to the traditional buyout space – where operating teams are becoming more prevalent and managers are investing in technology to improve deal sourcing and due diligence efficiency – but it is placing increased emphasis on venture capital to access innovation and small company growth.

The challenge in the latter area is manager selection. With start-ups delaying IPOs and spending more time under private ownership, VC firms are raising growth funds so they can continue to enjoy the upside and offering companies more operational assistance as they scale up. Nevertheless, this hasn’t translated into improved returns. “The dispersion between the top and bottom quartiles is large and average market performance has been, well, average,” Norris said.

Venture capital is expected to remain a key part of the Future Fund portfolio. However, participation is contingent on not only finding top managers but also adapting processes and expectations – specifically looking more closely at individual companies and accepting that holding periods will be longer.

For private markets more generally, the onus is on downside protection through careful portfolio construction. “We think about how much we invest in illiquid asset classes so that we don’t have problems if there is a major market crash,” Norris said, adding that Future Fund regularly tests the portfolio under different worst-case scenarios to see how it would hold up.

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• Topics
• Australasia
• LPs
• Performance
• Australia
• Future Fund
• AVCAL
• Australian Investment Council (AIC)