Australian LPs sacrificing higher returns due to fee concerns - AVCJ Forum

"Australia is beginning to look like New Zealand on this issue where superannuation funds are surrendering the opportunity to make returns to which their members are rightfully entitled," said Tim Sims, managing director at Pacific Equity Partners. He noted that Australian GPs distributed a record A$4.4 billion ($3.4 billion) to LPs in the 12 months ended September 2014 - a return of 25% net of fees and carried interest - but most of that went to overseas investors.

Following the introduction of the MySuper legislation, intended to reform the superannuation industry and deliver easily comparable products with a competitive focus on net costs and returns, a number of groups have scaled back or abandoned their private equity programs. Even those that retain allocations to the asset class are overly fixated on cost - and that is ultimately to their detriment.

John Brakey, advisor at Principle Advisory Services, said he knew of six leading offshore funds that have closed in the last six months and excluded Australian investors because they are too difficult to handle. "You go in to talk about fundraising but you spend 20-30 minutes talking about fees," he said. "It might be good therapy for investors to get it off their chests, but are you in this asset class or not? If you are in then it's up to you to deal with the fees."

Brakey stressed that he was not advocating acceptance of whatever terms GPs propose - it is LPs' responsibility to get the best deal they can on fees and eliminate misalignments of interest within fund structures - but that fees should not be allowed to dominate GP-LP exchanges.

"We are going to see some odd managers getting funded because of a different fee structures. While some managers should be weeded out they are not going to be," he added. The result will be underperformance.

Fees may be the most high-profile obstacle to superannuation participation in private equity, but they are not the only one. Sims noted there are tensions between LPs and GPs in Australia, in part because "there is a misplaced sense that we don't have the same cultural and excellence objectives."

Another issue is performance and the fact that many superannuation funds started building their international PE exposure as the market was peaking in the mid-2000s and then suffered from the global financial crisis backlash. Speaking on another panel at the forum, David Simons, director for private equity at Future Fund, said superannuation funds came in at "the wrong part of the vintage cycle," and in that context, decisions taken in 2009-2010 to back away from the asset class were understandable.

Furthermore, superannuation funds are under different kinds of pressure in terms of liabilities. "You cannot treat all LPs as this homogenous group," said Neil Stanford, private equity investment manager at HOSTPLUS. While some have young membership bases and are growing assets - making it easier to absorb commitments to illiquid assets - others have members who are approaching retirement and therefore need cash on hand for payouts.

"Instead of categorizing LPs as industry, corporate and retail funds, we should categorize them by membership demographics, cash flows and member switching," he said. "If you have these three characteristics [in your favor] it gives you a huge ability to do private equity and other long-term investments."

There are already industry lobbying efforts designed to convince superannuation funds and their trustee boards that private equity can deliver returns that justify the costs involved. Michael Weaver, private markets manager at SunSuper, observed that GPs should be able to do a better job in explaining the asset class. At the same time, regulators are not oblivious to problem.

"They don't think it should be a race to the bottom," Weaver said. "They understand that private equity is different - owning and operating 8-10 companies in a fund as opposed to sitting behind a Bloomberg terminal and picking 10-20 stocks."

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